Strategic Management Chapter 06

Pearce−Robinson: II. Strategy Formulation 6.
Formulating Long−Term © The McGraw−Hill

Strategic Management, Objectives and Grand Companies, 2004
Ninth Edition Strategies
Chapter Six
Formulating Long-Term
Objectives and Grand
Strategies
Company mission
and social
responsibility
(Chapter 2)
External environment
• Remote Internal
Possible?
• Industry (global analysis
and domestic) (Chapter 5)
• Operating
(Chapters 3, 4)
Desired?
Strategic analysis and choice

(Chapter 7: Creating competitive advantage at the business level)
(Chapter 8: Building value in multibusiness companies)
Feedback
Feedback
Long-term objectives Generic and grand strategies

(Chapter 6) (Chapter 6)
Short-term objectives;
Functional tactics Policies that empower action
reward system (Chapter 9) (Chapter 9)
(Chapter 9)
Restructuring, reengineering, and

refocusing the organization
(Chapter 10)
Strategic control and continuous improvement

(Chapter 11)
Legend
Major impact
Minor impact
Pearce−Robinson: II. Strategy Formulation 6. Formulating Long−Term © The McGraw−Hill
Chapter 6 Formulating Long-Term Objectives and Grand Strategies 191
The company mission was described in Chapter 2 as encompassing the broad aims of the
firm. The most specific statement of aims presented in that chapter appeared as the goals
of the firm. However, these goals, which commonly dealt with profitability, growth, and
survival, were stated without specific targets or time frames. They were always to be pur-
sued but could never be fully attained. They gave a general sense of direction but were not
intended to provide specific benchmarks for evaluating the firm’s progress in achieving its
aims. Providing such benchmarks is the function of objectives.1
The first part of this chapter will focus on long-term objectives. These are statements of
the results a firm seeks to achieve over a specified period, typically three to five years. The
second part will focus on the formulation of grand strategies. These provide a comprehen-
sive general approach in guiding major actions designed to accomplish the firm’s long-term
objectives.
The chapter has two major aims: (1) to discuss in detail the concept of long-term objec-
tives, the topics they cover, and the qualities they should exhibit; and (2) to discuss the con-
cept of grand strategies and to describe the 15 principal grand strategy options that are
available to firms singly or in combination, including three newly popularized options that
are being used to provide the basis for global competitiveness.
LONG-TERM OBJECTIVES
Strategic managers recognize that short-run profit maximization is rarely the best approach
to achieving sustained corporate growth and profitability. An often repeated adage states
that if impoverished people are given food, they will eat it and remain impoverished; how-
ever, if they are given seeds and tools and shown how to grow crops, they will be able to
improve their condition permanently. A parallel choice confronts strategic decision makers:
1. Should they eat the seeds to improve the near-term profit picture and make large divi-
dend payments through cost-saving measures such as laying off workers during periods
of slack demand, selling off inventories, or cutting back on research and development?
2. Or should they sow the seeds in the effort to reap long-term rewards by reinvesting prof-
its in growth opportunities, committing resources to employee training, or increasing
advertising expenditures?
For most strategic managers, the solution is clear—distribute a small amount of profit
now but sow most of it to increase the likelihood of a long-term supply. This is the most fre-
quently used rationale in selecting objectives.
To achieve long-term prosperity, strategic planners commonly establish long-term ob-
jectives in seven areas:
Profitability The ability of any firm to operate in the long run depends on attaining an ac-
ceptable level of profits. Strategically managed firms characteristically have a profit ob-
jective, usually expressed in earnings per share or return on equity.
Productivity Strategic managers constantly try to increase the productivity of their sys-
tems. Firms that can improve the input-output relationship normally increase profitability.
Thus, firms almost always state an objective for productivity. Commonly used productivity
objectives are the number of items produced or the number of services rendered per unit of
1
The terms goals and objectives are each used to convey a special meaning, with goals being the less
specific and more encompassing concept. Most authors follow this usage; however, some use the two
words interchangeably, while others reverse the usage.
192 Part Two Strategy Formulation
input. However, productivity objectives sometimes are stated in terms of desired cost de-
creases. For example, objectives may be set for reducing defective items, customer com-
plaints leading to litigation, or overtime. Achieving such objectives increases profitability
if unit output is maintained.
Competitive Position One measure of corporate success is relative dominance in the mar-
ketplace. Larger firms commonly establish an objective in terms of competitive position,
often using total sales or market share as measures of their competitive position. An objec-
tive with regard to competitive position may indicate a firm’s long-term priorities. For ex-
ample, Gulf Oil set a five-year objective of moving from third to second place as a producer
of high-density polypropylene. Total sales were the measure.
Employee Development Employees value education and training, in part because they
lead to increased compensation and job security. Providing such opportunities often in-
creases productivity and decreases turnover. Therefore, strategic decision makers fre-
quently include an employee development objective in their long-range plans. For example,
PPG has declared an objective of developing highly skilled and flexible employees and,
thus, providing steady employment for a reduced number of workers.
Employee Relations Whether or not they are bound by union contracts, firms actively
seek good employee relations. In fact, proactive steps in anticipation of employee needs and
expectations are characteristic of strategic managers. Strategic managers believe that pro-
ductivity is linked to employee loyalty and to appreciation of managers’ interest in em-
ployee welfare. They, therefore, set objectives to improve employee relations. Among the
outgrowths of such objectives are safety programs, worker representation on management
committees, and employee stock option plans.
Technological Leadership Firms must decide whether to lead or follow in the market-
place. Either approach can be successful, but each requires a different strategic posture.
Therefore, many firms state an objective with regard to technological leadership. For ex-
ample, Caterpillar Tractor Company established its early reputation and dominant position
in its industry by being in the forefront of technological innovation in the manufacture of
large earthmovers. E-commerce technology officers will have more of a strategic role in the
management hierarchy of the future, demonstrating that the Internet has become an integral
aspect of corporate long-term objective setting. In offering an e-technology manager
higher-level responsibilities, a firm is pursuing a leadership position in terms of innovation
in computer networks and systems. Officers of e-commerce technology at GE and Delta Air
have shown their ability to increase profits by driving down transaction-related costs with
Web-based technologies that seamlessly integrate their firms’ supply chains. These tech-
nologies have the potential to “lock in” certain suppliers and customers and heighten com-
petitive position through supply chain efficiency.
Public Responsibility Managers recognize their responsibilities to their customers and to

society at large. In fact, many firms seek to exceed government requirements. They work
not only to develop reputations for fairly priced products and services but also to establish
themselves as responsible corporate citizens. For example, they may establish objectives for
charitable and educational contributions, minority training, public or political activity, com-
munity welfare, or urban revitalization. In an attempt to exhibit their public responsibility
in the United States, Japanese companies, such as Toyota, Hitachi, and Matsushita, con-
tribute more than $500 million annually to American educational projects, charities, and
nonprofit organizations.
Qualities of Long-Term Objectives

What distinguishes a good objective from a bad one? What qualities of an objective improve
its chances of being attained? These questions are best answered in relation to seven crite-
ria that should be used in preparing long-term objectives: acceptable, flexible, measurable
over time, motivating, suitable, understandable, and achievable.
Acceptable Managers are most likely to pursue objectives that are consistent with their
preferences. They may ignore or even obstruct the achievement of objectives that offend
them (e.g., promoting a high-sodium food product) or that they believe to be inappropriate
or unfair (e.g., reducing spoilage to offset a disproportionate allocation of fixed overhead).
In addition, long-term corporate objectives frequently are designed to be acceptable to
groups external to the firm. An example is efforts to abate air pollution that are undertaken
at the insistence of the Environmental Protection Agency.
Flexible Objectives should be adaptable to unforeseen or extraordinary changes in the

firm’s competitive or environmental forecasts. Unfortunately, such flexibility usually is in-
creased at the expense of specificity. One way of providing flexibility while minimizing its
negative effects is to allow for adjustments in the level, rather than in the nature, of objectives.
For example, the personnel department objective of providing managerial development train-
ing for 15 supervisors per year over the next five-year period might be adjusted by changing
the number of people to be trained. In contrast, changing the personnel department’s objec-
tive of “assisting production supervisors in reducing job-related injuries by 10 percent per
year” after three months had gone by would understandably create dissatisfaction.
Measurable Objectives must clearly and concretely state what will be achieved and when
it will be achieved. Thus, objectives should be measurable over time. For example, the ob-
jective of “substantially improving our return on investment” would be better stated as “in-
creasing the return on investment on our line of paper products by a minimum of 1 percent
a year and a total of 5 percent over the next three years.”
Motivating People are most productive when objectives are set at a motivating level—one
high enough to challenge but not so high as to frustrate or so low as to be easily attained. The
problem is that individuals and groups differ in their perceptions of what is high enough. A
broad objective that challenges one group frustrates another and minimally interests a third.
One valuable recommendation is that objectives be tailored to specific groups. Developing
such objectives requires time and effort, but objectives of this kind are more likely to motivate.
Suitable Objectives must be suited to the broad aims of the firm, which are expressed in
its mission statement. Each objective should be a step toward the attainment of overall
goals. In fact, objectives that are inconsistent with the company mission can subvert the
firm’s aims. For example, if the mission is growth oriented, the objective of reducing the
debt-to-equity ratio to 1.00 would probably be unsuitable and counterproductive.
Understandable Strategic managers at all levels must understand what is to be achieved.

They also must understand the major criteria by which their performance will be evaluated.
Thus, objectives must be so stated that they are as understandable to the recipient as they are
to the giver. Consider the misunderstandings that might arise over the objective of “increas-
ing the productivity of the credit card department by 20 percent within two years.” What does
this objective mean? Increase the number of outstanding cards? Increase the use of outstand-
ing cards? Increase the employee workload? Make productivity gains each year? Or hope that
the new computer-assisted system, which should improve productivity, is approved by year 2?
As this simple example illustrates, objectives must be clear, meaningful, and unambiguous.
Achievable Finally, objectives must be possible to achieve. This is easier said than done.
Turbulence in the remote and operating environments affects a firm’s internal operations,
creating uncertainty and limiting the accuracy of the objectives set by strategic manage-
ment. To illustrate, the rapidly declining U.S. economy in 2000–2003 made objective set-
ting extremely difficult, particularly in such areas as sales projections.
The Balanced Scorecard

The Balanced Scorecard is a set of measures that are directly linked to the company’s strat-
egy. Developed by Robert S. Kaplan and David P. Norton, it directs a company to link its
own long-term strategy with tangible goals and actions. The scorecard allows managers to
evaluate the company from four perspectives: financial performance, customer knowledge,
internal business processes, and learning and growth.
The Balanced Scorecard, as shown in Exhibit 6–1, contains a concise definition of the com-
pany’s vision and strategy. Surrounding the vision and strategy are four additional boxes; each
box contains the objectives, measures, targets, and initiatives for one of the four perspectives:
• The box at the top of Exhibit 6–1 represents the financial perspective, and answers the
question “To succeed financially, how should we appear to our shareholders?”
• The box to the right represents the internal business process perspective and addresses
the question “To satisfy our shareholders and customers, what business processes must
we excel at?”
• The learning and growth box at the bottom of Exhibit 6–1 answers the question “To
achieve our vision, how will we sustain our ability to change and improve?”
• The box at the left reflects the customer perspective, and responds to the question “To
achieve our vision, how should we appear to our customers?”
EXHIBIT 6–1 The The balanced scorecard provides a framework to translate a strategy into operational terms
Balanced Scorecard
Financial
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as a Strategic Management appear to our
System,” by Robert S. Kaplan shareholders?"
and David P. Norton, Jan.–Feb.
1996. Copyright © 1996 by the
Harvard Business School
Publishing Corporation; all Customer Internal business process
rights reserved.
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All of the boxes are connected by arrows to illustrate that the objectives and measures of
the four perspectives are linked by cause-and-effect relationships that lead to the success-
ful implementation of the strategy. Achieving one perspective’s targets should lead to de-
sired improvements in the next perspective, and so on, until the company’s performance
increases overall.
A properly constructed scorecard is balanced between short- and long-term measures;
financial and nonfinancial measures; and internal and external performance perspectives.
The Balanced Scorecard is a management system that can be used as the central organ-
izing framework for key managerial processes. Chemical Bank, Mobil Corporation’s US
Marketing and Refining Division, and CIGNA Property and Casualty Insurance have used
the Balanced Scorecard approach to assist in individual and team goal setting, compensa-
tion, resource allocation, budgeting and planning, and strategic feedback and learning.
GENERIC STRATEGIES
Many planning experts believe that the general philosophy of doing business declared by
the firm in the mission statement must be translated into a holistic statement of the firm’s
strategic orientation before it can be further defined in terms of a specific long-term strat-
egy. In other words, a long-term or grand strategy must be based on a core idea about how
the firm can best compete in the marketplace.
The popular term for this core idea is generic strategy. From a scheme developed by
Michael Porter, many planners believe that any long-term strategy should derive from a
firm’s attempt to seek a competitive advantage based on one of three generic strategies:
1. Striving for overall low-cost leadership in the industry.
2. Striving to create and market unique products for varied customer groups through
differentiation.
3. Striving to have special appeal to one or more groups of consumer or industrial buyers,
focusing on their cost or differentiation concerns.
Advocates of generic strategies believe that each of these options can produce above-
average returns for a firm in an industry. However, they are successful for very different
reasons.
Low-cost leaders depend on some fairly unique capabilities to achieve and sustain their
low-cost position. Examples of such capabilities are: having secured suppliers of scarce raw
materials, being in a dominant market share position, or having a high degree of capitaliza-
tion. Low-cost producers usually excel at cost reductions and efficiencies. They maximize
economies of scale, implement cost-cutting technologies, stress reductions in overhead and
in administrative expenses, and use volume sales techniques to propel themselves up the
earning curve. The commonly accepted requirements for successful implementation of the
low-cost and the other two generic strategies are overviewed in Exhibit 6–2.
A low-cost leader is able to use its cost advantage to charge lower prices or to enjoy
higher profit margins. By so doing, the firm effectively can defend itself in price wars, at-
tack competitors on price to gain market share, or, if already dominant in the industry, sim-
ply benefit from exceptional returns. As an extreme case, it has been argued that National
Can Company, a corporation in an essentially stagnant industry, is able to generate attrac-
tive and improving profits by being the low-cost producer.
Strategies dependent on differentiation are designed to appeal to customers with a spe-
cial sensitivity for a particular product attribute. By stressing the attribute above other prod-
uct qualities, the firm attempts to build customer loyalty. Often such loyalty translates into
EXHIBIT 6–2 Generic Commonly Required Skills Common Organizational

Requirements for
Strategy and Resources Requirements
Generic Competitive
Strategies Overall cost Sustained capital investment and Tight cost control.
leadership access to capital. Frequent, detailed control reports.
Source: Free Press Competitive
Strategy: Techniques for Process engineering skills. Structured organization and
Analyzing Industries and Intense supervision of labor. responsibilities.
Competitors, pp. 40–41.
Reprinted with permission of Products designed for ease in Incentives based on meeting strict
the Free Press, a division of manufacture. quantitative targets.
Simon & Schuster, from
Competitive Strategy: Low-cost distribution system.
Techniques for Analyzing
Industries and Competitors, by
Differentiation Strong marketing abilities. Strong coordination among
Michael E. Porter. Copyright © Product engineering. functions in R&D, product devel-
1980 by Michael E. Porter. opment, and marketing.
Creative flare.
Strong capability in basic research. Subjective measurement and
incentives instead of quantitative
Corporate reputation for quality
measures.
or technological leadership.
Amenities to attract highly skilled
Long tradition in the industry or
labor scientists, or creative people.
unique combination of skills
drawn from other businesses.
Strong cooperation from channels.
Focus Combination of the above policies Combination of the above policies
directed at the particular strategic directed at the regular strategic
target. target.
a firm’s ability to charge a premium price for its product. Cross-brand pens, Brooks Broth-
ers suits, Porsche automobiles, and Chivas Regal Scotch whiskey are all examples.
The product attribute also can be the marketing channels through which it is delivered,
its image for excellence, the features it includes, and the service network that supports it.
As a result of the importance of these attributes, competitors often face “perceptual” barri-
ers to entry when customers of a successfully differentiated firm fail to see largely identi-
cal products as being interchangeable. For example, General Motors hopes that customers
will accept “only genuine GM replacement parts.”
A focus strategy, whether anchored in a low-cost base or a differentiation base, attempts
to attend to the needs of a particular market segment. Likely segments are those that are ig-
nored by marketing appeals to easily accessible markets, to the “typical” customer, or to
customers with common applications for the product. A firm pursuing a focus strategy is
willing to service isolated geographic areas; to satisfy the needs of customers with special
financing, inventory, or servicing problems; or to tailor the product to the somewhat unique
demands of the small- to medium-sized customer. The focusing firms profit from their will-
ingness to serve otherwise ignored or underappreciated customer segments. The classic ex-
ample is cable television. An entire industry was born because of a willingness of cable
firms to serve isolated rural locations that were ignored by traditional television services.
Brick producers that typically service a radius of less than 100 miles and commuter airlines
that serve regional geographic areas are other examples of industries where a focus strat-
egy frequently yields above-average industry profits.
While each of the generic strategies enables a firm to maximize certain competitive advan-
tages, each one also exposes the firm to a number of competitive risks. For example, a low-cost
leader fears a new low-cost technology that is being developed by a competitor; a differentiat-
ing firm fears imitators; and a focused firm fears invasion by a firm that largely targets cus-
tomers.As Exhibit 6–3 suggests, each generic strategy presents the firm with a number of risks.
EXHIBIT 6–3 Risks of Cost Leadership Risks of Differentiation Risks of Focus

Risks of the Generic
Strategies Cost of leadership is not Differentiation is not The focus strategy is
sustained: sustained: imitated.
Source: Free Press Competitive
Advantage: Creating and
• Competitors imitate. • Competitors imitate. The target segment
Sustaining Superior • Technology changes. • Bases for differentiation becomes structurally unat-
Performance, p. 21. Adapted • Other bases for cost become less important to tractive:
with the permission of the Free
Press, a division of Simon &
leadership erode. buyers. • Structure erodes.
Schuster, from Competitive • Demand disappears.
Strategy: Creating and
Sustaining Superior
Proximity in differentiation Cost proximity is lost. Broadly targeted
Performance, by Michael is lost. competitors overwhelm
E. Porter. Copyright © 1985 the segment:
by Michael E. Porter.
• The segment’s differences
from other segments
narrow.
• The advantages of a
broad line increase.
Cost focusers achieve even Differentiation focusers New focusers subsegment
lower cost in segments. achieve even greater differ- the industry.
entiation in segments.
THE VALUE DISCIPLINES

International management consultants Michael Treacy and Fred Wiersema propose an al-
ternative approach to generic strategy that they call the value disciplines.2 They believe that
strategies must center on delivering superior customer value through one of three value dis-
ciplines: operational excellence, customer intimacy, or product leadership.
Operational excellence refers to providing customers with convenient and reliable prod-
ucts or services at competitive prices. Customer intimacy involves offerings tailored to
match the demands of identified niches. Product leadership, the third discipline, involves
offering customers leading-edge products and services that make rivals’ goods obsolete.
Companies that specialize in one of these disciplines, while simultaneously meeting in-
dustry standards in the other two, gain a sustainable lead in their markets. This lead is de-
rived from the firm’s focus on one discipline, aligning all aspects of operations with it.
Having decided on the value that must be conveyed to customers, firms understand more
clearly what must be done to attain the desired results. After transforming their organiza-
tions to focus on one discipline, companies can concentrate on smaller adjustments to pro-
duce incremental value. To match this advantage, less focused companies require larger
changes than the tweaking that discipline leaders need.
Operational Excellence
Operational excellence is a specific strategic approach to the production and delivery of
products and services. A company that follows this strategy attempts to lead its industry in
price and convenience by pursuing a focus on lean and efficient operations. Companies that
employ operational excellence work to minimize costs by reducing overhead, eliminating
intermediate production steps, reducing transaction costs, and optimizing business
2
The ideas and examples in this section are drawn from Michael Treacy and Fred Wiersema, “Customer
Intimacy and Other Value Disciplines,” Harvard Business Review, 71(1): 84–94, 1993.
processes across functional and organizational boundaries. The focus is on delivering prod-
ucts or services to customers at competitive prices with minimal inconvenience.
Through its focus on operational excellence, Dell Computer has shown PC buyers that
they do not have to sacrifice quality of state-of-the art technology in order to buy personal
computers easily and inexpensively. Dell recognized the opportunity to cut retail dealers out
of the industry’s traditional distribution process. Through this approach—which includes
direct sales, building to order, and creating a disciplined, extremely low-cost culture—Dell
has been able to undercut other PC makers in price yet provide high-quality products and
service.
Operational excellence is also the strategic focus of General Electric’s large appliance
business. Historically, the distribution strategy for large appliances was based on requiring
that dealers maintain large inventories. Price breaks for dealers were based on order quan-
tities. However, as the marketplace became more competitive, principally as a result of com-
petition for multibrand dealers like Sears, GE recognized the need to adjust its production
and distribution plans.
The GE system addresses the delivery of products. As a step toward organizational ex-
cellence, GE created a computer-based logistics system to replace its in-store inventories
model. Retailers use this software to access a 24-hour on-line order processing system that
guarantees GE’s best price. This system allows dealers to better meet customer needs, with
instantaneous access to a warehouse of goods and accurate shipping and production infor-
mation. GE benefits from the deal as well. Efficiency is increased since manufacturing now
occurs in response to customer sales. Additionally, warehousing and distribution systems
have been streamlined to create the capability of delivering to 90 percent of destinations in
the continental United States within one business day.
Firms that implement the strategy of operational excellence typically restructure their
delivery processes to focus on efficiency and reliability, and use state-of-the art informa-
tion systems that emphasize integration and low-cost transactions.
Customer Intimacy
Companies that implement a strategy of customer intimacy continually tailor and shape
products and services to fit an increasingly refined definition of the customer. Companies
excelling in customer intimacy combine detailed customer knowledge with operational
flexibility. They respond quickly to almost any need, from customizing a product to fulfill-
ing special requests to create customer loyalty.
Customer-intimate companies are willing to spend money now to build customer loyalty
for the long term, considering each customer’s lifetime value to the company, not the profit
of any single transaction. Consequently, employees in customer-intimate companies go to
great lengths to ensure customer satisfaction with low regard for initial cost.
Home Depot implements the discipline of customer intimacy. Home Depot clerks spend
the necessary time with customers to determine the product that best suits their needs, be-
cause the company’s business strategy is built around selling information and service in ad-
dition to home-repair and improvement items. Consequently, consumers concerned solely
with price fall outside Home Depot’s core market.
Companies engaged in customer intimacy understand the difference between the prof-
itability of a single transaction and the profitability of a lifetime relationship with a single
customer. The company’s profitability depends in part on its maintaining a system that dif-
ferentiates quickly and accurately the degree of service that customers require and the rev-
enues their patronage is likely to generate. Firms using this approach recognize that not
every customer is equally profitable. For example, a financial services company installed a
telephone-computer system capable of recognizing individual clients by their telephone

numbers when they call. The system routes customers with large accounts and frequent
transactions to their own senior account representative. Other customers may be routed to
a trainee or junior representative. In any case, the customer’s file appears on the represen-
tative’s screen before the phone is answered.
The new system allows the firm to segment its services with great efficiency. If the com-
pany has clients who are interested in trading in a particular financial instrument, it can
group them under the one account representative who specializes in that instrument. This
saves the firm the expense of training every representative in every facet of financial serv-
ices. Additionally, the company can direct certain value-added services or products to a spe-
cific group of clients that would have interest in them.
Businesses that select a customer intimacy strategy have decided to stress flexibility
and responsiveness. They collect and analyze data from many sources. Their organiza-
tional structure emphasizes empowerment of employees close to customers. Additionally,
hiring and training programs stress the creative decision-making skills required to meet in-
dividual customer needs. Management systems recognize and utilize such concepts as cus-
tomer lifetime value, and norms among employees are consistent with a “have it your way”
mind set.
Product Leadership
Companies that pursue the discipline of product leadership strive to produce a continuous
stream of state-of-the-art products and services. Three challenges must be met to attain that
goal. Creativity is the first challenge. Creativity is recognizing and embracing ideas usually
originating outside the company. Second, innovative companies must commercialize ideas
quickly. Thus, their business and management processes need to be engineered for speed.
Product leaders relentlessly pursue new solutions to problems. Finally, firms utilizing this
discipline prefer to release their own improvements rather than wait for competitors to en-
ter. Consequently, product leaders do not stop for self-congratulation; they focus on con-
tinual improvement.
For example, Johnson & Johnson’s organizational design brings good ideas in, develops
them quickly, and looks for ways to improve them. In 1983, the president of J&J’s Vistakon,
Inc., a maker of specialty contact lenses, received a tip concerning an ophthalmologist who
had conceived of a method to manufacture disposable contact lenses inexpensively.
Vistakon’s president received this tip from a J&J employee from a different subsidiary
whom he had never met. Rather than dismiss the tip, the executives purchased the rights to
the technology, assembled a management team to oversee the product’s development team
to oversee the product’s development, and built a state-of-the-art facility in Florida to man-
ufacture disposable contact lenses called Acuvue. Vistakon and its parent, J&J, were will-
ing to incur high manufacturing and inventory costs before a single lens was sold. A
high-speed production facility helped give Vistakon a six-month head start over the com-
petition that, taken off guard, never caught up.
Like other product leaders, J&J creates and maintains an environment that encourages
employees to share ideas. Additionally, product leaders continually scan the environment
for new product or service possibilities and rush to capitalize them. Product leaders also
avoid bureaucracy because it slows commercialization of their ideas. In a product leader-
ship company, a wrong decision often is less damaging than one made late. As a result,
managers make decisions quickly, their companies encouraging them to decide today and
implement tomorrow. Product leaders continually look for new methods to shorten their cy-
cle times.
The strength of product leaders lies in reacting to situations as they occur. Shorter reaction
times serve as an advantage in dealings with the unknown. For example, when competitors
challenged the safety of Acuvue lenses, the firm responded quickly and distributed data com-
bating the charges to eye-care professionals.This reaction created goodwill in the marketplace.
Product leaders act as their own competition. These firms continually make the products
and services they have created obsolete. Product leaders believe that if they do not develop
a successor, a competitor will. So, although Acuvue is successful in the marketplace, Vis-
takon continues to investigate new material that will extend the wearability of contact lenses
and technologies that will make current lenses obsolete. J&J and other innovators recognize
that the long-run profitability of an existing product or service is less important to the com-
pany’s future than maintaining its product leadership edge and momentum.
GRAND STRATEGIES
While the need for firms to develop generic strategies remains an unresolved debate, de-
signers of planning systems agree about the critical role of grand strategies. Grand strate-
gies, often called master or business strategies, provide basic direction for strategic actions.
They are the basis of coordinated and sustained efforts directed toward achieving long-term
business objectives.
The purpose of this section is twofold: (1) to list, describe, and discuss 15 grand strate-
gies that strategic managers should consider and (2) to present approaches to the selection
of an optimal grand strategy from the available alternatives.
Grand strategies indicate the time period over which long-range objectives are to be
achieved. Thus, a grand strategy can be defined as a comprehensive general approach that
guides a firm’s major actions.
The 15 principal grand strategies are: concentrated growth, market development, prod-
uct development, innovation, horizontal integration, vertical integration, concentric diver-
sification, conglomerate diversification, turnaround, divestiture, liquidation, bankruptcy,
joint ventures, strategic alliances, and consortia. Any one of these strategies could serve as
the basis for achieving the major long-term objectives of a single firm. But a firm involved
with multiple industries, businesses, product lines, or customer groups—as many firms
are—usually combines several grand strategies. For clarity, however, each of the principal
grand strategies is described independently in this section, with examples to indicate some
of its relative strengths and weaknesses.
Concentrated Growth
Many of the firms that fell victim to merger mania were once mistakenly convinced that the
best way to achieve their objectives was to pursue unrelated diversification in the search for
financial opportunity and synergy. By rejecting that “conventional wisdom,” such firms as
Martin-Marietta, KFC, Compaq, Avon, Hyatt Legal Services, and Tenant have demonstrated
the advantages of what is increasingly proving to be sound business strategy. A firm that has
enjoyed special success through a strategic emphasis on increasing market share through
concentration is Chemlawn. With headquarters in Columbus, Ohio, Chemlawn is the North
American leader in professional lawn care. Like others in the lawn-care industry, Chemlawn
is experiencing a steadily declining customer base. Market analysis shows that the decline
is fueled by negative environmental publicity, perceptions of poor customer service, and
concern about the price versus the value of the company’s services, given the wide array of
do-it-yourself alternatives. Chemlawn’s approach to increasing market share hinges on ad-
dressing quality, price, and value issues; discontinuing products that the public or environ-
mental authorities perceive as unsafe; and improving the quality of its workforce.
These firms are just a few of the majority of American firms that pursue a concentrated
growth strategy by focusing on a specific product and market combination. Concentrated
growth is the strategy of the firm that directs its resources to the profitable growth of a sin-
gle product, in a single market, with a single dominant technology. The main rationale for
this approach, sometimes called a market penetration or concentration strategy, is that the
firm thoroughly develops and exploits its expertise in a delimited competitive arena.
Rationale for Superior Performance

Concentrated growth strategies lead to enhanced performance. The ability to assess market
needs, knowledge of buyer behavior, customer price sensitivity, and effectiveness of pro-
motion are characteristics of a concentrated growth strategy. Such core capabilities are a
more important determinant of competitive market success than are the environmental
forces faced by the firm. The high success rates of new products also are tied to avoiding
situations that require undeveloped skills, such as serving new customers and markets, ac-
quiring new technology, building new channels, developing new promotional abilities, and
facing new competition.
A major misconception about the concentrated growth strategy is that the firm practic-
ing it will settle for little or no growth. This is certainly not true for a firm that correctly uti-
lizes the strategy. A firm employing concentrated growth grows by building on its
competences, and it achieves a competitive edge by concentrating in the product-market
segment it knows best. A firm employing this strategy is aiming for the growth that results
from increased productivity, better coverage of its actual product-market segment, and more
efficient use of its technology.
Conditions That Favor Concentrated Growth

Specific conditions in the firm’s environment are favorable to the concentrated growth strat-
egy. The first is a condition in which the firm’s industry is resistant to major technological
advancements. This is usually the case in the late growth and maturity stages of the prod-
uct life cycle and in product markets where product demand is stable and industry barriers,
such as capitalization, are high. Machinery for the paper manufacturing industry, in which
the basic technology has not changed for more than a century, is a good example.
An especially favorable condition is one in which the firm’s targeted markets are not
product saturated. Markets with competitive gaps leave the firm with alternatives for
growth, other than taking market share away from competitors. The successful introduction
of traveler services by Allstate and Amoco demonstrates that even an organization as en-
trenched and powerful as the AAA could not build a defensible presence in all segments of
the automobile club market.
A third condition that favors concentrated growth exists when the firm’s product mar-
kets are sufficiently distinctive to dissuade competitors in adjacent product markets from
trying to invade the firm’s segment. John Deere scrapped its plans for growth in the con-
struction machinery business when mighty Caterpillar threatened to enter Deere’s mainstay,
the farm machinery business, in retaliation. Rather than risk a costly price war on its own
turf, Deere scrapped these plans.
A fourth favorable condition exists when the firm’s inputs are stable in price and quan-
tity and are available in the amounts and at the times needed. Maryland-based Giant Foods
is able to concentrate in the grocery business largely due to its stable long-term arrange-
ments with suppliers of its private-label products. Most of these suppliers are makers of the
national brands that compete against the Giant labels. With a high market share and ag-
gressive retail distribution, Giant controls the access of these brands to the consumer. Con-
sequently, its suppliers have considerable incentive to honor verbal agreements, called
bookings, in which they commit themselves for a one-year period with regard to the price,
quality, and timing of their shipments to Giant.
The pursuit of concentrated growth also is favored by a stable market—a market with-
out the seasonal or cyclical swings that would encourage a firm to diversify. Night Owl Se-
curity, the District of Columbia market leader in home security services, commits its
customers to initial four-year contracts. In a city where affluent consumers tend to be quite
transient, the length of this relationship is remarkable. Night Owl’s concentrated growth
strategy has been reinforced by its success in getting subsequent owners of its customers’
homes to extend and renew the security service contracts. In a similar way, Lands’ End re-
inforced its growth strategy by asking customers for names and addresses of friends and rel-
atives living overseas who would like to receive Lands’ End catalogs.
A firm also can grow while concentrating, if it enjoys competitive advantages based on
efficient production or distribution channels. These advantages enable the firm to formu-
late advantageous pricing policies. More efficient production methods and better handling
of distribution also enable the firm to achieve greater economies of scale or, in conjunc-
tion with marketing, result in a product that is differentiated in the mind of the consumer.
Graniteville Company, a large South Carolina textile manufacturer, enjoyed decades of
growth and profitability by adopting a “follower” tactic as part of its concentrated growth
strategy. By producing fabrics only after market demand had been well established, and by
featuring products that reflected its expertise in adopting manufacturing innovations and in
maintaining highly efficient long production runs, Graniteville prospered through concen-
trated growth.
Finally, the success of market generalists creates conditions favorable to concentrated
growth. When generalists succeed by using universal appeals, they avoid making special ap-
peals to particular groups of customers. The net result is that many small pockets are left
open in the markets dominated by generalists, and that specialists emerge and thrive in these
pockets. For example, hardware store chains, such as Home Depot, focus primarily on rou-
tine household repair problems and offer solutions that can be easily sold on a self-service,
do-it-yourself basis. This approach leaves gaps at both the “semiprofessional” and “neo-
phyte” ends of the market—in terms of the purchaser’s skill at household repairs and the ex-
tent to which available merchandise matches the requirements of individual homeowners.
Risk and Rewards of Concentrated Growth

Under stable conditions, concentrated growth poses lower risk than any other grand strat-
egy; but, in a changing environment, a firm committed to concentrated growth faces high
risks. The greatest risk is that concentrating in a single product market makes a firm par-
ticularly vulnerable to changes in that segment. Slowed growth in the segment would jeop-
ardize the firm because its investment, competitive edge, and technology are deeply
entrenched in a specific offering. It is difficult for the firm to attempt sudden changes if its
product is threatened by near-term obsolescence, a faltering market, new substitutes, or
changes in technology or customer needs. For example, the manufacturers of IBM clones
faced such a problem when IBM adopted the OS/2 operating system for its personal com-
puter line. That change made existing clones out of date.
The concentrating firm’s entrenchment in a specific industry makes it particularly sus-
ceptible to changes in the economic environment of that industry. For example, Mack
Truck, the second-largest truck maker in America, lost $20 million as a result of an 18-
month slump in the truck industry.
Entrenchment in a specific product market tends to make a concentrating firm more
adept than competitors at detecting new trends. However, any failure of such a firm to prop-
erly forecast major changes in its industry can result in extraordinary losses. Numerous
makers of inexpensive digital watches were forced to declare bankruptcy because they
failed to anticipate the competition posed by Swatch, Guess, and other trendy watches that
emerged from the fashion industry.
A firm pursuing a concentrated growth strategy is vulnerable also to the high opportu-
nity costs that result from remaining in a specific product market and ignoring other op-
tions that could employ the firm’s resources more profitably. Overcommitment to a specific
technology and product market can hinder a firm’s ability to enter a new or growing prod-
uct market that offers more attractive cost-benefit trade-offs. Had Apple Computers main-
tained its policy of making equipment that did not interface with IBM equipment, it would
have missed out on what have proved to be its most profitable strategic options.
Concentrated Growth Is Often the Most Viable Option

Examples abound of firms that have enjoyed exceptional returns on the concentrated
growth strategy. Such firms as McDonald’s, Goodyear, and Apple Computers have used
firsthand knowledge and deep involvement with specific product segments to become pow-
erful competitors in their markets. The strategy is associated even more often with suc-
cessful smaller firms that have steadily and doggedly improved their market position.
The limited additional resources necessary to implement concentrated growth, coupled
with the limited risk involved, also make this strategy desirable for a firm with limited funds.
For example, through a carefully devised concentrated growth strategy, medium-sized John
Deere & Company was able to become a major force in the agricultural machinery business
even when competing with such firms as Ford Motor Company. While other firms were try-
ing to exit or diversify from the farm machinery business, Deere spent $2 billion in up-
grading its machinery, boosting its efficiency, and engaging in a program to strengthen its
dealership system. This concentrated growth strategy enabled it to become the leader in the
farm machinery business despite the fact that Ford was more than 10 times its size.
The firm that chooses a concentrated growth strategy directs its resources to the prof-
itable growth of a narrowly defined product and market, focusing on a dominant technol-
ogy. Firms that remain within their chosen product market are able to extract the most from
their technology and market knowledge and, thus, are able to minimize the risk associated
with unrelated diversification. The success of a concentration strategy is founded on the
firm’s use of superior insights into its technology, product, and customer to obtain a sus-
tainable competitive advantage. Superior performance on these aspects of corporate strat-
egy has been shown to have a substantial positive effect on market success.
A grand strategy of concentrated growth allows for a considerable range of action.
Broadly speaking, the firm can attempt to capture a larger market share by increasing the
usage rates of present customers, by attracting competitors’ customers, or by selling to
nonusers. In turn, each of these options suggests more specific options, some of which are
listed in the top section of Exhibit 6–4.
When strategic managers forecast that their current products and their markets will not
provide the basis for achieving the company mission, they have two options that involve
moderate costs and risk: market development and product development.
Market Development
Market development commonly ranks second only to concentration as the least costly and
least risky of the 15 grand strategies. It consists of marketing present products, often with
only cosmetic modifications, to customers in related market areas by adding channels of
distribution or by changing the content of advertising or promotion. Several specific mar-
ket development approaches are listed in Exhibit 6–4. Thus, as suggested by the figure,
EXHIBIT 6–4 Concentration (increasing use of present products in present markets):

Specific Options
under the Grand 1. Increasing present customers’ rate of use:
Strategies of a. Increasing the size of purchase.
Concentration, b. Increasing the rate of product obsolescence.
Market Development, c. Advertising other uses.
and Product d. Giving price incentives for increased use.
Development 2. Attracting competitors’ customers:
a. Establishing sharper brand differentiation.
Source: Adapted from Philip
Kotler, Marketing Management
b. Increasing promotional effort.
Analysis, Planning, and c. Initiating price cuts.
Control, 11th ed., 2002. 3. Attracting nonusers to buy the product:
Reprinted by permission of
Prentice Hall, Inc., Upper
a. Inducing trial use through sampling, price incentives, and so on.
Saddle River, NJ. b. Pricing up or down.
c. Advertising new uses.
Market development (selling present products in new markets):
1. Opening additional geographic markets:
a. Regional expansion.
b. National expansion.
c. International expansion.
2. Attracting other market segments:
a. Developing product versions to appeal to other segments.
b. Entering other channels of distribution.
c. Advertising in other media.
Product development (developing new products for present markets):
1. Developing new product features:
a. Adapt (to other ideas, developments).
b. Modify (change color, motion, sound, odor, form, shape).
c. Magnify (stronger, longer, thicker, extra value).
d. Minify (smaller, shorter, lighter).
e. Substitute (other ingredients, process, power).
f. Rearrange (other patterns, layout, sequence, components).
g. Reverse (inside out).
h. Combine (blend, alloy, assortment, ensemble; combine units, purposes, appeals, ideas).
2. Developing quality variations.
3. Developing additional models and sizes (product proliferation).
firms that open branch offices in new cities, states, or countries are practicing market de-
velopment. Likewise, firms are practicing market development if they switch from ad-
vertising in trade publications to advertising in newspapers or if they add jobbers to
supplement their mail-order sales efforts. Kmart pursued market development with its re-
cent emphasis on increasing market share among Hispanics as described in Strategy in
Action Exhibit 6–5.
Market development allows firms to practice a form of concentrated growth by identi-
fying new uses for existing products and new demographically, psychographically, or ge-
ographically defined markets. Frequently, changes in media selection, promotional
appeals, and distribution are used to initiate this approach. Du Pont used market develop-
ment when it found a new application for Kevlar, an organic material that police, security,
and military personnel had used primarily for bulletproofing. Kevlar now is being used to
Strategy in Action
Kmart Con Salsa: Will It Be Enough? Exhibit 6–5
Move over, Martha. Here comes Kmart is coming late to this party. Wal-Mart and Sears,
Thalia. The sexy Mexico-born pop star Roebuck & Co. several years ago began letting local managers
is about to add some sizzle to Kmart buy products suited to their communities. Kmart’s previous
Corp.’s tired image. Industry sources say the queen of Latin pop management thought it more efficient for buyers at head-
will lend her name to a new line of clothing, shoes, and cos- quarters to purchase for stores nationwide. But, says CEO
metics for Kmart. Although unknown to many English-speaking James B. Adamson, who took over in March, “people sitting
Americans, Thalia (pronounced Tah-lee-ah) has a big following in Troy, Mich., can’t understand the difference between stores
among Hispanics in the United States. The exclusive apparel line in Los Angeles, New York, Texas, or Miami.”
is part of a new strategy to woo Hispanic shoppers that may be That’s why Adamson is giving store managers more say
Kmart’s best hope for reviving its flagging business. over what goes on their shelves. For Frank Gonzales, manager
For years, Kmart has struggled to find a niche between of a San Jose (Calif.) Kmart, that means selling tortilla warm-
Wal-Mart’s low prices and Target’s cheap chic. Kmart’s biggest ers, tamale pots, and such produce as avocados, mangoes,
failure, last year’s price war with Wal-Mart, helped land the and cilantro. “We were missing a lot of those sales,” says
company in bankruptcy court. Now, in its bid to survive, Kmart Gonzales.
is latching on to the one advantage it has over its discount ri- Kmart knows its Hispanic focus must not be seen as pan-
vals: stores in heavily populated urban areas. That means dering. “They’ve got to know you’re not giving them lip serv-
catering more to multicultural consumers, who already make ice,” says Adamson, who is credited with turning around the
up nearly 40 percent of Kmart’s sales. Denny’s restaurant chain after complaints of racial discrimina-
Thalia’s line is just the start. Kmart says it hopes to an- tion tarnished its image. In an effort to build loyalty, Kmart is
nounce a similar deal with an African American celebrity by launching on Sept. 15 La Vida, a four-page weekly magazine
year-end. Meanwhile, it is adding more Hispanic merchandise in Spanish to go out with a new Spanish ad circular. It will fea-
to its stores and reaching out to Hispanics with new Spanish- ture celebrities and lifestyle articles.
language ads and publications. “It’s a very strong step Kmart With Hispanics expected to outnumber African Americans
is taking,” says Kurt Barnard, publisher of Barnard’s Retail by 2009, this may be Kmart’s best chance. But it will take more
Trend Report. “It’s going to pay big dividends.” than Hispanic shoppers to save the company. Its problems—
The strategy isn’t risk-free. Kmart could alienate its existing ranging from poor inventory controls to lousy distribution—
customers if it swings too far toward the Hispanic market. And are deep-seated and can’t be fixed overnight. But getting
Wal-Mart, already targeting Hispanics, plans to open more ur- shoppers back is a start. And Thalia may help.
ban stores. “There’s a window of opportunity for Kmart,” says
Ira Kalish, chief economist at Columbus (Ohio) consultant Re- Source: By Joann Muller in Troy, Mich., with Wendy Zellner in Dallas.
tail Forward, Inc., “But it’s going to close quickly.” BusinessWeek, September 9, 2002, p. 46.
refit and maintain wooden-hulled boats, since it is lighter and stronger than glass fibers
and has 11 times the strength of steel.
The medical industry provides other examples of new markets for existing products. The
National Institutes of Health’s report of a study showing that the use of aspirin may lower
the incidence of heart attacks was expected to boost sales in the $2.2 billion analgesic mar-
ket. It was predicted that the expansion of this market would lower the market share of
nonaspirin brands, such as industry leaders Tylenol and Advil. Product extensions currently
planned include Bayer Calendar Pack, 28-day packaging to fit the once-a-day prescription
for the prevention of a second heart attack.
Another example is Chesebrough-Ponds, a major producer of health and beauty aids,
which decided several years ago to expand its market by repacking its Vaseline Petroleum
Jelly in pocket-size squeeze tubes as Vaseline “Lip Therapy.” The corporation decided to
place a strategic emphasis on market development, because it knew from market studies
that its petroleum-jelly customers already were using the product to prevent chapped lips.
Company leaders reasoned that their market could be expanded significantly if the product
were repackaged to fit conveniently in consumers’ pockets and purses.
205
Strategy in Action
Call It the Pepsi Blue Generation Exhibit 6–6
PepsiCo Corp. diverted some of its Code Red, Twist, Blue, and Mist accounted for barely 5 per-
advertising attention away from its cent of Pepsi’s soft-drink sales. In the past, Pepsi might not
flagship cola toward newer and nar- have bothered with such small fry. In 2003, though, it was
rower brands like Sierra Mist and Pepsi Twist. It was the latest looking for products that could crack a hard-to-reach demo-
sign of how the soft-drink giant had reformulated its mission graphic group. Code Red, for example, had reeled in urban-
from bolstering core brands like Pepsi-Cola and Mountain ites, women, and African Americans who had not previously
Dew to peppering the market with niche products and brand shown any impulse to do the Dew. That could have helped off-
extensions. Pepsi’s market had splintered and big brands no set flagship Pepsi’s 2 percent volume sales decline in 2002.
longer had universal appeal. To attract a younger, less cohesive Because these new drinks were more narrowly targeted,
generation, Purchase (N.Y.)-based Pepsi had to rethink the Pepsi had to refine its marketing techniques. To launch Code
way it developed and marketed its wares. “The era of the mass Red in 2001, the company handed out a million samples at
brand has been over for a long time,” said David Burwick, youth magnets like the Winter X Games and the NCAA Final
chief marketing officer of Pepsi-Cola North America. Four basketball tourney before the brand was available in
Pepsi’s response had been a raft of new products, most stores. That helped create a buzz that got Code Red off to a
bearing the Pepsi or Mountain Dew names. Its biggest hit had brisk start. For teen-oriented Pepsi Blue last fall, Pepsi went be-
been cherry-flavored, caffeine-loaded Mountain Dew Code yond hiring rock stars to appear in ads. Instead, it worked out
Red. Pepsi Twist and berry-flavored Pepsi Blue had developed an innovative deal with Universal Music Group.
more modest followings. Sierra Mist was a youth-skewed chal- Source: Excerpted from Gerry Khermouch, “Call It the Pepsi Blue
lenger to Cadbury Schweppes PLC’s 7 Up. Generation.” BusinessWeek, February 3, 2003, p. 96.
Product Development
Product development involves the substantial modification of existing products or the cre-
ation of new but related products that can be marketed to current customers through estab-
lished channels. The product development strategy often is adopted either to prolong the
life cycle of current products or to take advantage of a favorite reputation or brand name.
The idea is to attract satisfied customers to new products as a result of their positive expe-
rience with the firm’s initial offering. The bottom section in Exhibit 6–4 lists some of the
options available to firms undertaking product development. A revised edition of a college
textbook, a new car style, and a second formula of shampoo for oily hair are examples of
the product development strategy.
A detailed example of Pepsi’s product development activities is provided in Exhibit 6–6,
Strategy in Action. In 2001, Pepsi changed its strategy on beverage products by creating new
products to follow the industry movement away from mass branding. This new movement was
designed to attract a younger, hipper customer segment. Pepsi’s new products include a version
of Mountain Dew, called Code Red, and new Pepsi brands, called Pepsi Twist and Pepsi Blue.
The product development strategy is based on the penetration of existing markets by in-
corporating product modifications into existing items or by developing new products with
a clear connection to the existing product line. The telecommunications industry provides
an example of product extension based on product modification. To increase its estimated
8 to 10 percent share of the $5 to $6 billion corporate user market, MCI Communication
Corporation extended its direct-dial service to 146 countries, the same as those serviced by
AT&T, at lower average rates than those of AT&T. MCI’s addition of 79 countries to its net-
work underscores its belief in this market, which it expects to grow 15 to 20 percent annu-
ally. Another example of expansions linked to existing lines is Gerber’s decision to engage
in general merchandise marketing. Gerber’s recent introduction included 52 items that
ranged from feeding accessories to toys and children’s wear. Likewise, Nabisco Brands
seeks competitive advantage by placing its strategic emphasis on product development.
206
With headquarters in Parsippany, New Jersey, the company is one of three operating units
of RJR Nabisco. It is the leading producer of biscuits, confections, snacks, shredded cere-
als, and processed fruits and vegetables. To maintain its position as leader, Nabisco pursues
a strategy of developing and introducing new products and expanding its existing product
line. Spoon Size Shredded Wheat and Ritz Bits crackers are two examples of new products
that are variations on existing products.
Innovation
In many industries, it has become increasingly risky not to innovate. Both consumer and in-
dustrial markets have come to expect periodic changes and improvements in the products
offered. As a result, some firms find it profitable to make innovation their grand strategy.
They seek to reap the initially high profits associated with customer acceptance of a new or
greatly improved product. Then, rather than face stiffening competition as the basis of prof-
itability shifts from innovation to production or marketing competence, they search for
other original or novel ideas. The underlying rationale of the grand strategy of innovation
is to create a new product life cycle and thereby make similar existing products obsolete.
Thus, this strategy differs from the product development strategy of extending an existing
product’s life cycle. For example, Intel, a leader in the semiconductor industry, pursues ex-
pansion through a strategic emphasis on innovation. With headquarters in California, the
company is a designer and manufacturer of semiconductor components and related com-
puters, of microcomputer systems, and of software. Its Pentium microprocessor gives a
desktop computer the capability of a mainframe.
While most growth-oriented firms appreciate the need to be innovative occasionally, a
few firms use it as their fundamental way of relating to their markets. An outstanding ex-
ample is Polaroid, which heavily promotes each of its new cameras until competitors are
able to match its technological innovation; by this time, Polaroid normally is prepared to in-
troduce a dramatically new or improved product. For example, it introduced consumers in
quick succession to the Swinger, the SX-70, the One Step, and the Sun Camera 660.
Few innovative ideas prove profitable because the research, development, and pre-
marketing costs of converting a promising idea into a profitable product are extremely high.
A study by the Booz Allen & Hamilton management research department provides some
understanding of the risks. As shown in Exhibit 6–7, Booz Allen & Hamilton found that less
EXHIBIT 6–7 60
Decay of New
Product Ideas (51 55
Companies)
Screening
Number of ideas
20
15 One successful
Business analysis new product
Development Commercialization
10
Testing
5
10 20 30 40 50 60 70 80 90 100
Cumulative time (percent)
Global Strategy in Action

Deutsche Telekom Growth Strategy of Horizontal Acquisition Exhibit 6–8
Measured against the nation’s wire- this year. That has set off a torrent of criticism that it has wildly
less giants, VoiceStream Wireless overpaid for its position. However, Deutsche Telekom’s CEO
Corp. has been a bit of a pipsqueak. Sommer is confident. Here’s what he considered when he
So why would Germany’s Deutsche Telekom pay an eye- agreed to the price: VoiceStream owns licenses in 23 of the
popping $21,639 per subscriber for the little Bellevue, Wash- top 25 U.S. markets. In wireless lingo, its licenses cover areas
ington, cell phone company? Simply put, Deutsche Telekom with a 220 million subscriber base. Though it has relatively few
is not buying subscribers in the United States. It’s buying po- subscribers signed up and currently does not actually provide
tential—in this case, the potential to become a dominant service to many of the locales where it holds licenses, it is
player—not just in the United States, but globally. By the end adding subscribers at a sizzling pace—an 18.5 percent growth
of 2000, only about 32.5 percent of the U.S. population was rate that is among the top in the industry.
using some form of wireless compared with 52 percent in Eu- Wireless companies across the country are taking note,
rope and 60 percent in Japan. Growth prospects in such a rel- given DT’s deep pockets and promise to make a starting in-
atively undeveloped market, the German executives reckon, vestment of at least $5 billion in VoiceStream. With the $5 bil-
are so high that their company will emerge almost immedi- lion, VoiceStream can accelerate construction of wireless
ately as a formidable rival. U.S. telecom execs say a DT- systems in places like California and Ohio. Stanton estimates
VoiceStream link will force U.S. players to step up efforts to that the cash infusion will help him push up the roll-out of his
provide wireless Net service to a broader market, including service by 6 to 18 months. Also, Deutsche Telekom’s cash is ex-
overseas. pected to allow VoiceStream to participate in a major way in
To gain this kind of sway over the lucrative U.S. market and the upcoming auction of more spectrum licenses by the FCC.
the global market, Deutsche Telekom felt it was worth signifi-
cantly besting the $4,390 per subscriber Britain’s Vodafone Source: Excerpted from R. O. Crockett and D. Fairlamb, August 7,
paid for AirTouch in 1999 or the estimated $12,400 that the 2000, “Deutsche Telekom’s Wireless Wager,” BusinessWeek (3693),
combined Vodafone-AirTouch paid for Mannesmann earlier pp. 30–32.
than 2 percent of the innovative projects initially considered by 51 companies eventually

reached the marketplace. Specifically, out of every 58 new product ideas, only 12 pass an
initial screening test that finds them compatible with the firm’s mission and long-term ob-
jectives, only 7 remain after an evaluation of their potential, and only 3 survive develop-
ment attempts. Of the three survivors, two appear to have profit potential after test
marketing and only one is commercially successful.
Horizontal Integration
When a firm’s long-term strategy is based on growth through the acquisition of one or more
similar firms operating at the same stage of the production-marketing chain, its grand strat-
egy is called horizontal integration. Such acquisitions eliminate competitors and provide
the acquiring firm with access to new markets. One example is Warner-Lambert’s acquisi-
tion of Parke Davis, which reduced competition in the ethical drugs field for Chilcott Lab-
oratories, a firm that Warner-Lambert previously had acquired. Another example is the
long-range acquisition pattern of White Consolidated Industries, which expanded in the re-
frigerator and freezer market through a grand strategy of horizontal integration, by acquir-
ing Kelvinator Appliance, the Refrigerator Products Division of Bendix Westinghouse
Automotive Air Brake, and Frigidaire Appliance from General Motors. Nike’s acquisition
in the dress shoes business and N. V. Homes’s purchase of Ryan Homes have vividly ex-
emplified the success that horizontal integration strategies can bring.
Exhibit 6–8, Global Strategy in Action, describes Deutsche Telekom growth strategy of
horizontal acquisition. Deutsche Telekom was a dominant player in the European wireless
services market, but without a presence in the fast-growing U.S. market. To correct this lim-
208
itation, Deutsche Telekom horizontally integrated by purchasing the American firm Voice-
Stream Wireless, a company that was growing faster than most domestic rivals and that
owned spectrum licenses providing access to 220 million potential customers.
Vertical Integration
When a firm’s grand strategy is to acquire firms that supply it with inputs (such as raw ma-
terials) or are customers for its outputs (such as warehousers for finished products), verti-
cal integration is involved. To illustrate, if a shirt manufacturer acquires a textile
producer—by purchasing its common stock, buying its assets, or exchanging ownership in-
terests—the strategy is vertical integration. In this case, it is backward vertical integration,
since the acquired firm operates at an earlier stage of the production-marketing process. If
the shirt manufacturer had merged with a clothing store, it would have been forward verti-
cal integration—the acquisition of a firm nearer to the ultimate consumer.
Amoco emerged as North America’s leader in natural gas reserves and products as a re-
sult of its acquisition of Dome Petroleum. This backward integration by Amoco was made
in support of its downstream businesses in refining and in gas stations, whose profits made
the acquisition possible.
Exhibit 6–9 depicts both horizontal and vertical integration. The principal attractions of
a horizontal integration grand strategy are readily apparent. The acquiring firm is able to
greatly expand its operations, thereby achieving greater market share, improving economies
of scale, and increasing the efficiency of capital use. In addition, these benefits are achieved
with only moderately increased risk, since the success of the expansion is principally de-
pendent on proven abilities.
The reasons for choosing a vertical integration grand strategy are more varied and some-
times less obvious. The main reason for backward integration is the desire to increase the
dependability of the supply or quality of the raw materials used as production inputs. That
desire is particularly great when the number of suppliers is small and the number of com-
petitors is large. In this situation, the vertically integrating firm can better control its costs
and, thereby, improve the profit margin of the expanded production-marketing system. For-
ward integration is a preferred grand strategy if great advantages accrue to stable produc-
tion. A firm can increase the predictability of demand for its output through forward
integration; that is, through ownership of the next stage of its production-marketing chain.
EXHIBIT 6–9
Vertical and Textile producer Textile producer
Horizontal
Integrations
Shirt manufacturer Shirt manufacturer
Clothing store Clothing store
Acquisitions or mergers of suppliers or customer businesses

are vertical integrations.
Acquisitions or mergers of competing businesses

are horizontal integrations.
Some increased risks are associated with both types of integration. For horizontally inte-
grated firms, the risks stem from increased commitment to one type of business. For verti-
cally integrated firms, the risks result from the firm’s expansion into areas requiring strategic
managers to broaden the base of their competences and to assume additional responsibilities.
Concentric Diversification
Grand strategies involving diversification represent distinctive departures from a firm’s ex-
isting base of operations, typically the acquisition or internal generation (spin-off) of a sep-
arate business with synergistic possibilities counterbalancing the strengths and weaknesses
of the two businesses. For example, Head Ski initially sought to diversify into summer
sporting goods and clothing to offset the seasonality of its “snow” business. However, di-
versifications occasionally are undertaken as unrelated investments, because of their high
profit potential and their otherwise minimal resource demands.
Regardless of the approach taken, the motivations of the acquiring firms are the same:
• Increase the firm’s stock value. In the past, mergers often have led to increases in the
stock price or the price-earnings ratio.
• Increase the growth rate of the firm.
• Make an investment that represents better use of funds than plowing them into inter-
nal growth.
• Improve the stability of earnings and sales by acquiring firms whose earnings and sales
complement the firm’s peaks and valleys.
• Balance or fill out the product line.
• Diversify the product line when the life cycle of current products has peaked.
• Acquire a needed resource quickly (e.g., high-quality technology or highly innovative
management).
• Achieve tax savings by purchasing a firm whose tax losses will offset current or future
earnings.
• Increase efficiency and profitability, especially if there is synergy between the acquiring
firm and the acquired firm.3
Concentric diversification involves the acquisition of businesses that are related to the
acquiring firm in terms of technology, markets, or products. With this grand strategy, the
selected new businesses possess a high degree of compatibility with the firm’s current busi-
nesses. The ideal concentric diversification occurs when the combined company profits in-
crease the strengths and opportunities and decrease the weaknesses and exposure to risk.
Thus, the acquiring firm searches for new businesses whose products, markets, distribution
channels, technologies, and resource requirements are similar to but not identical with its
own, whose acquisition results in synergies but not complete interdependence.
Conglomerate Diversification
Occasionally a firm, particularly a very large one, plans to acquire a business because it rep-
resents the most promising investment opportunity available. This grand strategy is com-
monly known as conglomerate diversification. The principal concern, and often the sole
3
Godfrey Devlin and Mark Bleackley, “Strategic Alliances—Guidelines for Success,” Long Range Planning,
October 1988, pp. 18–23.
Strategy in Action
Seven Deadly Sins of Strategy Acquisition Exhibit 6–10
1. The wrong target. 5. Management difficulties.
The first step to avoid such a mistake is for the acquiror and The remedy for this problem must be extracted from the
its financial advisors to determine the strategic goals and iden- initial strategic review. The management compensation struc-
tify the mission. The product of this strategic review will be ture must be designed with legal and business advisors to help
specifically identified criteria for the target. achieve those goals. The financial rewards to management
The second step required to identify the right target is to must depend upon the financial and strategic success of the
design and carry out an effective due diligence process to as- combined entity.
certain whether the target indeed has the identified set of
6. The closing crisis.
qualities selected in the strategic review.
Closing crises may stem from unavoidable changed condi-
2. The wrong price.
tions, but most often they result from poor communication.
The key to avoiding this problem lies in the acquiror’s valu- Negotiators sometimes believe that problems swept under the
ation model. The model will incorporate assumptions con- table maintain a deal’s momentum and ultimately allow for its
cerning industry trends and growth patterns developed in the consummation. They are sometimes right—and often wrong.
strategic review. Charting a course through an acquisition requires carefully de-
veloped skills for every kind of professional—business, ac-
3. The wrong structure.
counting, and legal.
The two principal aspects of the acquisition process that
7. The operating transition crisis.
can prevent this problem are a comprehensive regulatory com-
pliance review and tax and legal analysis. Even the best conceived and executed acquisition will pre-
vent significant transition and postclosing operation issues.
4. The lost deal.
Strategic goals cannot be achieved by quick asset sales or
The letter of intent must spell out not only the price to be other accelerated exit strategies. Management time and en-
paid but also many of the relational aspects that will make the ergy must be spent to ensure that the benefits identified in the
strategic acquisition successful. Although an acquiror may jus- strategic review are achieved.
tifiably focus on expenses, indemnification, and other logical
concerns in the letter of intent, relationship and operational Source: From Academy of Management Review by D.A. Tanner.
Copyright © 1991 by Academy of Management. Reproduced with
concerns are also important.
permission of Academy of Management via Copyright Clearance
Center.
concern, of the acquiring firm is the profit pattern of the venture. Unlike concentric diver-
sification, conglomerate diversification gives little concern to creating product-market syn-
ergy with existing businesses. What such conglomerate diversifiers as ITT, Textron,
American Brands, Litton, U.S. Industries, Fuqua, and I. C. Industries seek is financial syn-
ergy. For example, they may seek a balance in their portfolios between current businesses
with cyclical sales and acquired businesses with countercyclical sales, between high-
cash/low-opportunity and low-cash/high-opportunity businesses, or between debt-free and
highly leveraged businesses.
The principal difference between the two types of diversification is that concentric di-
versification emphasizes some commonality in markets, products, or technology, whereas
conglomerate diversification is based principally on profit considerations.
Several of the grand strategies discussed above, including concentric and conglomerate
diversification and horizontal and vertical integration, often involve the purchase or acquisi-
tion of one firm by another. It is important to know that the majority of such acquisitions fail
to produce the desired results for the companies involved. Exhibit 6–10, Strategy in Action,
provides seven guidelines that can improve a company’s chances of a successful acquisition.
211
Turnaround
For any one of a large number of reasons, a firm can find itself with declining profits. Among
these reasons are economic recessions, production inefficiencies, and innovative break-
throughs by competitors. In many cases, strategic managers believe that such a firm can sur-
vive and eventually recover if a concerted effort is made over a period of a few years to fortify
its distinctive competences. This grand strategy is known as turnaround. It typically is be-
gun through one of two forms of retrenchment, employed singly or in combination:
1. Cost reduction. Examples include decreasing the workforce through employee attri-
tion, leasing rather than purchasing equipment, extending the life of machinery, eliminat-
ing elaborate promotional activities, laying off employees, dropping items from a
production line, and discontinuing low-margin customers.
2. Asset reduction. Examples include the sale of land, buildings, and equipment not es-
sential to the basic activity of the firm and the elimination of “perks,” such as the company
airplane and executives’ cars.
Interestingly, the turnaround most commonly associated with this approach is in man-
agement positions. In a study of 58 large firms, researchers Shendel, Patton, and Riggs
found that turnaround almost always was associated with changes in top management.4
Bringing in new managers was believed to introduce needed new perspectives on the firm’s
situation, to raise employee morale, and to facilitate drastic actions, such as deep budget-
ary cuts in established programs.
Strategic management research provides evidence that the firms that have used a turnaround
strategy have successfully confronted decline. The research findings have been assimilated and
used as the building blocks for a model of the turnaround process shown in Exhibit 6–11.
The model begins with a depiction of external and internal factors as causes of a firm’s
performance downturn. When these factors continue to detrimentally impact the firm, its
financial health is threatened. Unchecked decline places the firm in a turnaround situation.
A turnaround situation represents absolute and relative-to-industry declining perfor-
mance of a sufficient magnitude to warrant explicit turnaround actions. Turnaround situa-
tions may be the result of years of gradual slowdown or months of sharp decline. In either
case, the recovery phase of the turnaround process is likely to be more successful in ac-
complishing turnaround when it is preceded by planned retrenchment that results in the
achievement of near-term financial stabilization. For a declining firm, stabilizing opera-
tions and restoring profitability almost always entail strict cost reduction followed by a
shrinking back to those segments of the business that have the best prospects of attractive
profit margins. The need for retrenchment was reflected in unemployment figures during
the 2000–2003 recession. More layoffs of American workers were announced in 2001 than
in any of the previous eight years when U.S. companies announced nearly 2 million layoffs
as the economy sunk into its first recession in a decade.
The immediacy of the resulting threat to company survival posed by the turnaround sit-
uation is known as situation severity. Severity is the governing factor in estimating the speed
with which the retrenchment response will be formulated and activated. When severity is
low, a firm has some financial cushion. Stability may be achieved through cost retrenchment
alone. When turnaround situation severity is high, a firm must immediately stabilize the de-
cline or bankruptcy is imminent. Cost reductions must be supplemented with more drastic
4
Other forms of joint ventures (such as leasing, contract manufacturing, and management contracting)
offer valuable support strategies. They are not included in the categorization, however, because they
seldom are employed as grand strategies.
EXHIBIT 6–11 A Model of the Turnaround Process

Turnaround situation Turnaround response
Cause Severity Retrenchment phase Recovery phase
(operating)
Internal Declining Cost Efficiency

factors sales or reduction maintenance
margins
Low
Stability Recovery
High
External Imminent Asset Entrepreneurial

factors bankruptcy reduction reconfiguration
(strategic)
asset reduction measures. Assets targeted for divestiture are those determined to be under-
productive. In contrast, more productive resources are protected from cuts and represent
critical elements of the future core business plan of the company (i.e., the intended recovery
response).
Turnaround responses among successful firms typically include two stages of strategic
activities: retrenchment and the recovery response. Retrenchment consists of cost-cutting
and asset-reducing activities. The primary objective of the retrenchment phase is to stabi-
lize the firm’s financial condition. Situation severity has been associated with retrenchment
responses among successful turnaround firms. Firms in danger of bankruptcy or failure
(i.e., severe situations) attempt to halt decline through cost and asset reductions. Firms in
less severe situations have achieved stability merely through cost retrenchment. However,
in either case, for firms facing declining financial performance, the key to successful turn-
around rests in the effective and efficient management of the retrenchment process.
The primary causes of the turnaround situation have been associated with the second phase
of the turnaround process, the recovery response. For firms that declined primarily as a result
of external problems, turnaround most often has been achieved through creative new entrepre-
neurial strategies. For firms that declined primarily as a result of internal problems, turnaround
has been most frequently achieved through efficiency strategies. Recovery is achieved when
economic measures indicate that the firm has regained its predownturn levels of performance.
Divestiture
A divestiture strategy involves the sale of a firm or a major component of a firm. Sara Lee
Corp. (SLE) provides a good example. It sells everything from Wonderbras and Kiwi shoe
polish to Endust furniture polish and Chock full o’Nuts coffee. The company used a con-
glomerate diversification strategy to build Sara Lee into a huge portfolio of disparate
brands. A new president, C. Steven McMillan, faced stagnant revenues and earnings. So
he consolidated, streamlined, and focused the company on its core categories—food,
underwear, and household products. He divested 15 businesses, including Coach leather

goods, which together equaled over 20 percent of the company’s revenue, and laid off
13,200 employees, nearly 10 percent of the workforce. McMillan used the cash from asset
sales to snap up brands that enhanced Sara Lee’s clout in key categories, like the $2.8 bil-
lion purchase of St. Louis-based breadmaker Earthgrains Co. to quadruple Sara Lee’s bak-
ery operations.
When retrenchment fails to accomplish the desired turnaround, as in the Goodyear situ-
ation, or when a nonintegrated business activity achieves an unusually high market value,
strategic managers often decide to sell the firm. However, because the intent is to find a
buyer willing to pay a premium above the value of a going concern’s fixed assets, the term
marketing for sale is often more appropriate. Prospective buyers must be convinced that be-
cause of their skills and resources or because of the firm’s synergy with their existing busi-
nesses, they will be able to profit from the acquisition.
As discussed in Exhibit 6–12, Strategy in Action, Corning undertook a turnaround that
followed retrenchment with divestitures. In 2001, Corning found itself in a declining mar-
ket for its core product of fiber optic cable. The company needed to develop a strategy that
would allow it to turnaround its falling sales and begin to grow once more. It began with re-
trenchment. Corning laid off 12,000 workers in 2001 and another 4,000 in 2002. Corning
also began the divestiture of its non-core assets, such as its non-telecom businesses, and its
money-losing photonics operation to stabilize its financial situation so that it could begin its
recovery.
The reasons for divestiture vary. They often arise because of partial mismatches between the
acquired firm and the parent corporation. Some of the mismatched parts cannot be integrated
into the corporation’s mainstream activities and, thus, must be spun off. A second reason is cor-
porate financial needs. Sometimes the cash flow or financial stability of the corporation as a
whole can be greatly improved if businesses with high market value can be sacrificed. The re-
sult can be a balancing of equity with long-term risks or of long-term debt payments to opti-
mize the cost of capital. A third, less frequent reason for divestiture is government antitrust
action when a firm is believed to monopolize or unfairly dominate a particular market.
Although examples of the divestiture grand strategy are numerous, CBS, Inc., provides
an outstanding example. In a two-year period, the once diverse entertainment and publish-
ing giant sold its Records Division to Sony, its magazine publishing business to Diamandis
Communications, its book publishing operations to Harcourt Brace Jovanovich, and its mu-
sic publishing operations to SBK Entertainment World. Other firms that have pursued this
type of grand strategy include Esmark, which divested Swift & Company, and White Mo-
tors, which divested White Farm.
Liquidation
When liquidation is the grand strategy, the firm typically is sold in parts, only occasionally as
a whole—but for its tangible asset value and not as a going concern. In selecting liquidation,
the owners and strategic managers of a firm are admitting failure and recognize that this ac-
tion is likely to result in great hardships to themselves and their employees. For these reasons,
liquidation usually is seen as the least attractive of the grand strategies. As a long-term strat-
egy, however, it minimizes the losses of all the firm’s stockholders. Faced with bankruptcy, the
liquidating firm usually tries to develop a planned and orderly system that will result in the
greatest possible return and cash conversion as the firm slowly relinquishes its market share.
Planned liquidation can be worthwhile. For example, Columbia Corporation, a $130 mil-
lion diversified firm, liquidated its assets for more cash per share than the market value of
its stock.
Strategy in Action
Corning’s “Very Narrow Straits” Exhibit 6–12
The year is 2002. Corning, the deeply Corning might need for operations if some of its short-term in-
weakened fiber-optic powerhouse, is vestments aren’t sellable, says Kingston. As of June 30, Corn-
trying to navigate between the tele- ing had $4.76 billion in property, plants, and equipment. Its
com meltdown and a looming liquidity squeeze. four fiber plants—two in North Carolina, one in Germany, and
When James Houghton left retirement to retake the reins one in Australia—are running at 40 percent capacity. The
at Corning (GLW) in June, 2001, the world’s largest fiber-optic larger, U.S.-based plants cost about $450 million each to
cable maker clearly had lost its footing. Its customers were cut- build, and Corning could, potentially, write off half of the ca-
ting their capital budgets as their own customers demanded pacity, or about $1 billion.
lower prices. Corning’s revenues were beginning to drop pre- Goodwill write-offs could be massive as well. Most of the
cipitously. Houghton, who joined Corning in 1962 and be- value in the $2 billion goodwill account comes from Corning’s
came its chairman and CEO before retiring in 1996, was optical-components business. Considering that several com-
returning just as his glass empire was starting to crack. panies currently trying to sell similar businesses are having a
Things haven’t improved much so far in 2002. Corning’s hard time getting even a few cents on the dollar, the write-off
sales, at $2 billion in the fourth quarter of 2000, reached only could be huge.
$896 million in the second quarter of 2002. That’s down 52 Corning could raise money by issuing more equity—and di-
percent from year-ago levels and slightly down from the first luting the interests of existing shareholders. Recently, it sold
quarter. Corning had already laid off 12,000 workers in 2001 $575 million of three-year mandatory convertible preferred
at its Corning (N.Y.) headquarters. But on July 23, it an- stock, with a coupon rate of 7 percent. Of course, Corning
nounced an additional 4,000 layoffs, bringing its workforce could sell some of its businesses for cash. Though it’s known
down to 28,000. Its stock, trading at $340 per share in 2000, mainly for its optical cable, Corning also makes glass for flat-
before a split, hit a new low of $1.50 on Aug. 1. Analysts say panel monitors, funnels for large-screen TVs, and frequency
a $2 billion credit line could be in jeopardy. And Corning controls for electronics. These businesses account for half of
might not reach profitability in 2003, as promised. It might its revenues, and many are growing and are profitable.
even have difficulty paying off $2.1 billion zero-coupon, con- Barring some unprecedented telecom turnaround, without
vertible bonds due in 2005. Ironically, no one is saying that more cost cuts Corning is unlikely to reach profitability in
Corning’s products are substandard. Just the opposite, in fact. 2003. That’s a long time to ask investors to hang tough in this
But that might not be enough to get it over a very tough fi- kind of market. And demand for fiber could remain weak for
nancial patch. three more years, says Russ McGuire, chief strategist at tele-
Liquidity remains a key concern. At the end of its most re- com consultancy TeleChoice. Even when it does turn up, de-
cent quarter, Corning had $940 million in cash and $383 mil- mand likely won’t soar. All of the major telecom networks are
lion in short-term investments. But the funds are needed for already built out, and the stretches that remain will require less
day-to-day operations, restructuring, and debt payments, so capacity—and less fiber, says Patrick Fay, an analyst at fiber-
by the end of 2003, Corning will go through most of that consultancy KMI.
stash. Standard & Poor’s has downgraded Corning’s credit rat-
ing to below investment grade, meaning the company could Source: Excerpted from Olga Kharif, “Corning’s ‘Very Narrow
have trouble raising additional funds—which are exactly what Straits.’ ” BusinessWeek Online, August 30, 2002.
Bankruptcy
Business failures are playing an increasingly important role in the American economy. In
an average week, more than 300 companies fail. More than 75 percent of these financially
desperate firms file for a liquidation bankruptcy—they agree to a complete distribution of
their assets to creditors, most of whom receive a small fraction of the amount they are owed.
Liquidation is what the layperson views as bankruptcy: The business cannot pay its debts,
so it must close its doors. Investors lose their money, employees lose their jobs, and man-
agers lose their credibility. In owner-managed firms, company and personal bankruptcy
commonly go hand in hand.
The other 25 percent of these firms refuse to surrender until one final option is ex-
hausted. Choosing a strategy to recapture its viability, such a company asks the courts for a
215
reorganization bankruptcy. The firm attempts to persuade its creditors to temporarily freeze
their claims while it undertakes to reorganize and rebuild the company’s operations more
profitably. The appeal of a reorganization bankruptcy is based on the company’s ability to
convince creditors that it can succeed in the marketplace by implementing a new strategic
plan, and that when the plan produces profits, the firm will be able to repay its creditors,
perhaps in full. In other words, the company offers its creditors a carefully designed alter-
native to forcing an immediate, but fractional, repayment of its financial obligations. The
option of reorganization bankruptcy offers maximum repayment of debt at some specified
future time if a new strategic plan is successful.
The Bankruptcy Situation

Imagine that your firm’s financial reports have shown an unabated decline in revenue for seven
quarters. Expenses have increased rapidly, and it is becoming difficult, and at times not possi-
ble, to pay bills as they become due. Suppliers are concerned about shipping goods without first
receiving payment, and some have refused to ship without advanced payment in cash. Cus-
tomers are requiring assurances that future orders will be delivered and some are beginning to
buy from competitors. Employees are listening seriously to rumors of financial problems and
a higher than normal number have accepted other employment. What can be done? What strat-
egy can be initiated to protect the company and resolve the financial problems in the short term?
The Harshest Resolution

If the judgment of the owners of a business is that its decline cannot be reversed, and the
business cannot be sold as a going concern, then the alternative that is in the best inter-
est of all may be a liquidation bankruptcy, also known as Chapter 7 of the Bankruptcy
Code. The court appoints a trustee, who collects the property of the company, reduces it
to cash, and distributes the proceeds proportionally to creditors on a pro rata basis as ex-
peditiously as possible. Since all assets are sold to pay outstanding debt, a liquidation
bankruptcy terminates a business. This type of filing is critically important to sole pro-
prietors or partnerships. Their owners are personally liable for all business debts not cov-
ered by the sale of the business assets unless they can secure a Chapter 7 bankruptcy,
which will allow them to cancel any debt in excess of exempt assets. Although they will
be left with little personal property, the liquidated debtor is discharged from paying the
remaining debt.
The shareholders of corporations are not liable for corporate debt and any debt existing
after corporate assets are liquidated is absorbed by creditors. Corporate shareholders may
simply terminate operations and walk away without liability to remaining creditors. How-
ever, filing a Chapter 7 proceeding will provide for an orderly and fair distribution of assets
to creditors and thereby may reduce the negative impact of the business failure.
A Conditional Second Chance

A proactive alternative for the endangered company is reorganization bankruptcy. Chosen
for the right reasons, and implemented in the right way, reorganization bankruptcy can pro-
vide a financially, strategically, and ethically sound basis on which to advance the interests
of all of the firm’s stakeholders.
A thorough and objective analysis of the company may support the idea of its continu-
ing operations if excessive debt can be reduced and new strategic initiatives can be under-
taken. If the realistic possibility of long-term survival exists, a reorganization under Chapter
11 of the Bankruptcy Code can provide the opportunity. Reorganization allows a business
debtor to restructure its debts and, with the agreement of creditors and approval of the court,
to continue as a viable business. Creditors involved in Chapter 11 actions often receive less
than the total debt due to them but far more than would be available from liquidation.
A Chapter 11 bankruptcy can provide time and protection to the debtor firm (which we
will call the Company) to reorganize and use future earnings to pay creditors. The Company
may restructure debts, close unprofitable divisions or stores, renegotiate labor contracts, re-
duce its workforce, or propose other actions that could create a profitable business. If the
plan is accepted by creditors, the Company will be given another chance to avoid liquida-
tion and emerge from the bankruptcy proceedings rehabilitated.
Seeking Protection of the Bankruptcy Court

If creditors file lawsuits or schedule judicial sales to enforce liens, the Company will need
to seek the protection of the Bankruptcy Court. Filing a bankruptcy petition will invoke the
protection of the court to provide sufficient time to work out a reorganization that was not
achievable voluntarily. If reorganization is not possible, a Chapter 7 proceeding will allow
for the fair and orderly dissolution of the business.
If a Chapter 11 proceeding is the required course of action, the Company must determine
what the reorganized business will look like, if such a structure can be achieved, and how
it will be accomplished while maintaining operations during the bankruptcy proceeding.
Will sufficient cash be available to pay for the proceedings and reorganization? Will cus-
tomers continue to do business with the Company or seek other more secure businesses
with which to deal? Will key personnel stay on or look for more secure employment? Which
operations should be discontinued or reduced?
Emerging from Bankruptcy

Bankruptcy is only the first step toward recovery for a firm. Many questions should be an-
swered: How did the business get to the point at which the extreme action of bankruptcy was
necessary? Were warning signs overlooked? Was the competitive environment understood?
Did pride or fear prevent objective analysis? Did the business have the people and resources
to succeed? Was the strategic plan well designed and implemented? Did financial problems
result from unforeseen and unforeseeable problems or from bad management decisions?
Commitments to “try harder,” “listen more carefully to the customer,” and “be more effi-
cient” are important but insufficient grounds to inspire stakeholder confidence. A recovery
strategy must be developed to delineate how the company will compete more successfully in
the future.
An assessment of the bankruptcy situation requires executives to consider the causes of
the Company’s decline and the severity of the problem it now faces. Investors must decide
whether the management team that governed the company’s operations during the down-
turn can return the firm to a position of success. Creditors must believe that the company’s
managers have learned how to prevent a recurrence of the observed and similar problems.
Alternatively, they must have faith that the company’s competencies can be sufficiently
augmented by key substitutions to the management team, with strong support in decision
making from a board of directors and consultants, to restore the firm’s competitive strength.
CORPORATE COMBINATIONS
The 15 grand strategies discussed above, used singly and much more often in combinations, rep-
resent the traditional alternatives used by firms in the United States. Recently, three new grand
types have gained in popularity; all fit under the broad category of corporate combinations. Al-
though they do not fit the criterion by which executives retain a high degree of control over their
operations, these grand strategies deserve special attention and consideration especially by com-
panies that operate in global, dynamic, and technologically driven industries. These three newly
popularized grand strategies are joint ventures, strategic alliances, and consortia.
Joint Ventures
Occasionally two or more capable firms lack a necessary component for success in a par-
ticular competitive environment. For example, no single petroleum firm controlled suffi-
cient resources to construct the Alaskan pipeline. Nor was any single firm capable of
processing and marketing all of the oil that would flow through the pipeline. The solution
was a set of joint ventures, which are commercial companies (children) created and oper-
ated for the benefit of the co-owners (parents). These cooperative arrangements provided
both the funds needed to build the pipeline and the processing and marketing capacities
needed to profitably handle the oil flow.
The particular form of joint ventures discussed above is joint ownership. In recent years,
it has become increasingly appealing for domestic firms to join foreign firms by means of
this form. For example, Diamond-Star Motors is the result of a joint venture between a U.S.
company, Chrysler Corporation, and Japan’s Mitsubishi Motors corporation. Located in
Normal, Illinois, Diamond-Star was launched because it offered Chrysler and Mitsubishi a
chance to expand on their long-standing relationship in which subcompact cars (as well as
Mitsubishi engines and other automotive parts) are imported to the United States and sold
under the Dodge and Plymouth names.
The joint venture extends the supplier-consumer relationship and has strategic advan-
tages for both partners. For Chrysler, it presents an opportunity to produce a high-quality
car using expertise brought to the venture by Mitsubishi. It also gives Chrysler the chance
to try new production techniques and to realize efficiencies by using the workforce that was
not included under Chrysler’s collective bargaining agreement with the United Auto Work-
ers. The agreement offers Mitsubishi the opportunity to produce cars for sale in the United
States without being subjected to the tariffs and restrictions placed on Japanese imports.
As a second example, Bethlehem Steel acquired an interest in a Brazilian mining ven-
ture to secure a raw material source. The stimulus for this joint ownership venture was grand
strategy, but such is not always the case. Certain countries virtually mandate that foreign
firms entering their markets do so on a joint ownership basis. India and Mexico are good
examples. The rationale of these countries is that joint ventures minimize the threat of for-
eign domination and enhance the skills, employment, growth, and profits of local firms.
It should be noted that strategic managers understandably are wary of joint ventures. Ad-
mittedly, joint ventures present new opportunities with risks that can be shared. On the other
hand, joint ventures often limit the discretion, control, and profit potential of partners, while
demanding managerial attention and other resources that might be directed toward the
firm’s mainstream activities. Nevertheless, increasing globalization in many industries may
require greater consideration of the joint venture approach, if historically national firms are
to remain viable.
Strategic Alliances
Strategic alliances are distinguished from joint ventures because the companies in-
volved do not take an equity position in one another. In many instances, strategic al-
liances are partnerships that exist for a defined period during which partners contribute
their skills and expertise to a cooperative project. For example, one partner provides
manufacturing capabilities while a second partner provides marketing expertise. Many
times, such alliances are undertaken because the partners want to learn from one an-
other with the intention to be able to develop in-house capabilities to supplant the part-
ner when the contractual arrangement between them reaches its termination date. Such
relationships are tricky since in a sense the partners are attempting to “steal” each
other’s know-how. Exhibit 6–13, Global Strategy in Action, lists many important

Key Issues in Strategic Alliance Learning Exhibit 6–13
Objective Major Questions

1. Assess and value partner • What were the strategic objectives in forming the alliance?
knowledge. • What are the core competencies of our alliance partner?
• What specific knowledge does the partner have that could enhance our
competitive strategy?
• What are the core partner skills relevant for our product/markets?
2. Determine knowledge • How have key alliance responsibilities been allocated to the partners?
accessibility. • Which partner controls key managerial responsibilities?
• Does the alliance agreement specify restrictions on our access to the alliance
operations?
3. Evaluate knowledge • Is our learning objective focused on explicit operational knowledge?

tacitness and ease of • Where in the alliance does the knowledge reside?
transfer. • Is the knowledge strategic or operational?
• Do we understand what we are trying to learn and how we can use the
knowledge?
4. Establish knowledge • Are parent managers in regular contact with senior alliance managers?
connections between the • Has the alliance been incorporated into parent strategic plans and do alliance
alliance and the partner. managers participate in parent strategic planning discussions?
• What is the level of trust between parent and alliance managers?
• Do alliance financial issues dominate meetings between alliance and parent
managers?
5. Draw on existing • In the learning process, have efforts been made to involve managers with prior
knowledge to facilitate experience in either/both alliance management and partner ties?
learning. • Are experiences with other alliances being used as the basis for managing the
current alliance?
• Are we realistic about our partner’s learning objectives?
• Are we open-minded about knowledge without immediate short-term applicability?
6. Ensure that partner and • Is the alliance viewed as a threat or an asset by parent managers?
alliance managerial • In the parent, is there agreement on the strategic rationale for the alliance?
cultures are in alignment. • In the alliance, do managers understand the importance of the parent’s learning
objective?
Source: From Academy of Management Executive: The Thinking Manager’s Source by Andrew C. Inkpen. Copyright 1998 by Academy of
Management. Reproduced with permission of Academy of Management via Copyright Clearance Center.
questions about their learning intentions that prospective partners should ask them-
selves before entering into a strategic alliance.
In other instances, strategic alliances are synonymous with licensing agreements. Li-
censing involves the transfer of some industrial property right from the U.S. licensor to a
motivated licensee in a foreign country. Most tend to be patents, trademarks, or technical
know-how that are granted to the licensee for a specified time in return for a royalty and for
avoiding tariffs or import quotas. Bell South and U.S. West, with various marketing and
219
service competitive advantages valuable to Europe, have extended a number of licenses to

create personal computer networks in the United Kingdom (U.K.).
Another licensing strategy open to U.S. firms is to contract the manufacturing of its
product line to a foreign company to exploit local comparative advantages in technology,
materials, or labor. For example, MIPS Computer Systems has licensed Digital Equipment
Corporation, Texas Instruments, Cypress Semiconductor, and Bipolar Integrated Technol-
ogy in the United States, and Fujitsu, NEC, and Kubota in Japan to market computers based
on its designs in the partner’s country.
Service and franchise-based firms—including Anheuser-Busch, Avis, Coca-Cola,
Hilton, Hyatt, Holiday Inns, Kentucky Fried Chicken, McDonald’s, and Pepsi—have long
engaged in licensing arrangements with foreign distributors as a way to enter new markets
with standardized products that can benefit from marketing economies.
Outsourcing is a rudimentary approach to strategic alliances that enables firms to gain a
competitive advantage. Significant changes within many segments of American business
continue to encourage the use of outsourcing practices. Within the health care arena, an in-
dustry survey recorded 67 percent of hospitals using provider outsourcing for at least one
department within their organization. Services such as information systems, reimburse-
ment, and risk and physician practice management are outsourced by 51 percent of the hos-
pitals that use outsourcing.
Another successful application of outsourcing is found in human resources. A survey of
human resource executives revealed 85 percent have personal experience leading an out-
sourcing effort within their organization. In addition, it was found that two-thirds of pen-
sion departments have outsourced at least one human resource function.
Within customer service and sales departments, outsourcing increased productivity in
such areas as product information, sales and order taking, sample fulfillment, and com-
plaint handling. Exhibit 6–14 presents the top five strategic and tactical reasons for ex-
ploiting the benefits of outsourcing.
EXHIBIT 6–14 1. Improve Business Focus.

The Top Five
For many companies, the single most compelling reason for outsourcing is that several
Strategic Reasons
“how” issues are siphoning off huge amounts of management’s resources and attention.
for Outsourcing
2. Access to World-Class Capabilities.
Source: Material prepared for a By the very nature of their specialization, outsourcing providers bring extensive
paid advertising section which worldwide, world-class resources to meeting the needs of their customers. Partnering
appeared in the October 16,
1995, issue of Fortune © 1995, with an organization with world-class capabilities can offer access to new technology,
Time, Inc. All rights reserved. tools, and techniques that the organization may not currently possess; better career
opportunities for personnel who transition to the outsourcing provider; more structured
methodologies, procedures, and documentation; and competitive advantage through
expanded skills.
3. Accelerated Reengineering Benefits.
Outsourcing is often a byproduct of another powerful management tool—business
process reengineering. It allows an organization to immediately realize the anticipated
benefits of reengineering by having an outside organization—one that is already reengi-
neered to world-class standards—take over the process.
4. Shared Risks.
When companies outsource they become more flexible, more dynamic, and better able
to adapt to changing opportunities.
5. Free Resources for Other Purposes.
Outsourcing permits an organization to redirect its resources from noncore activities
toward activities that have the greater return in serving the customer.
Consortia, Keiretsus, and Chaebols

Consortia are defined as large interlocking relationships between businesses of an indus-
try. In Japan such consortia are known as keiretsus, in South Korea as chaebols.
In Europe, consortia projects are increasing in number and in success rates. Examples
include the Junior Engineers’ and Scientists’ Summer Institute, which underwrites cooper-
ative learning and research; the European Strategic Program for Research and Development
in Information Technologies, which seeks to enhance European competitiveness in fields
related to computer electronics and component manufacturing; and EUREKA, which is a
joint program involving scientists and engineers from several European countries to coor-
dinate joint research projects.
A Japanese keiretsu is an undertaking involving up to 50 different firms that are joined
around a large trading company or bank and are coordinated through interlocking directories
and stock exchanges. It is designed to use industry coordination to minimize risks of com-
petition, in part through cost sharing and increased economies of scale. Examples include
Sumitomo, Mitsubishi, Mitsui, and Sanwa. Exhibit 6–15, Global Strategy in Action, presents
a new side to keiretsus, namely, that they are adding global partners, including several from
the United States. Their cooperative nature is growing in evidence as is their market success.
A South Korean chaebol resembles a consortium or keiretsu except that they are typi-
cally financed through government banking groups and largely are run by professional
managers trained by participating firms expressly for the job.
SELECTION OF LONG-TERM OBJECTIVES AND GRAND STRATEGY SETS

At first glance, the strategic management model, which provides the framework for study
throughout this book, seems to suggest that strategic choice decision making leads to the se-
quential selection of long-term objectives and grand strategies. In fact, however, strategic
choice is the simultaneous selection of long-range objectives and grand strategies. When
strategic planners study their opportunities, they try to determine which are most likely to
result in achieving various long-range objectives. Almost simultaneously, they try to fore-
cast whether an available grand strategy can take advantage of preferred opportunities so the
tentative objectives can be met. In essence, then, three distinct but highly interdependent
choices are being made at one time. Several triads, or sets, of possible decisions are usually
considered.
A simplified example of this process is shown in Exhibit 6–16. In this example, the
firm has determined that six strategic choice options are available. These options stem
from three interactive opportunities (e.g., West Coast markets that present little competi-
tion). Because each of these interactive opportunities can be approached through different
grand strategies—for options 1 and 2, the grand strategies are horizontal integration and
market development—each offers the potential for achieving long-range objectives to
varying degrees. Thus, a firm rarely can make a strategic choice only on the basis of its
preferred opportunities, long-range objectives, or grand strategy. Instead, these three ele-
ments must be considered simultaneously, because only in combination do they constitute
a strategic choice.
In an actual decision situation, the strategic choice would be complicated by a wider va-
riety of interactive opportunities, feasible company objectives, promising grand strategy op-
tions, and evaluative criteria. Nevertheless, Exhibit 6–16 does partially reflect the nature and
complexity of the process by which long-term objectives and grand strategies are selected.
In the next chapter, the strategic choice process will be fully explained. However, knowl-
edge of long-term objectives and grand strategies is essential to understanding that process.

Keiretsu Connections Exhibit 6–15
Amid rolling hills outside Nagoya, counterparts, mostly American, jumped 26 percent, to 155, in
Toshiba Corp. recently took the wraps the first quarter of 1996—on top of a 33 percent increase be-
off a new $1 billion chipmaking facil- tween 1993 and 1995—according to the Sakura Institute of
ity that uses ultraviolet lithography to etch circuits less than one Research.
micron wide—a tiny fraction of the width of a human hair.
The Toshiba chip site owes much to a strategic alliance with ENVY
IBM and Siemens of Germany. In fact, IBM’s know-how in And while Uncle Sam and U.S. companies with grievances
chemical mechanical polishing, essential to smoothing the tiny have attacked Japan’s system of big industrial groups, called
surfaces of multilayered chips, played a critical role. “We had keiretsu, as exclusionary, other chieftains of Corporate Amer-
little expertise here,” concedes Toshiba’s Koichi Suzuki. ica have quietly become stakeholders of sorts. The list includes
companies as diverse as IBM, General Motors, TRW, Boeing,
QUIET CHANGE and Caterpillar.
What’s more, about 20 IBM engineers will show up shortly to Many American executives who established these alliances
transfer the technology back to an IBM-Toshiba facility in say they appreciate the attributes of Japan’s big industrial
Manassas, Virginia. In addition to the semiconductor cooper- groups. U.S. managers have always envied the keiretsu edge
ation, IBM and Toshiba jointly make liquid-crystal display in spreading risk over a cluster of companies when betting on
panels—even though they use the LCDs in their fiercely com- a new technology or blitzing emerging markets.
petitive lines of laptop computers. “It’s no longer considered a In one industry after another, U.S. and Japanese partners
loss of corporate manhood to let others help out,” says IBM are breaking new ground in their level of cooperation. The im-
Asia Pacific President Robert C. Timpson. pact is felt far beyond the U.S. and Japanese home markets.
For years, many U.S. tie-ups with Japanese companies Take the 50–50 venture between Caterpillar Inc. and Mit-
tended to be defensive in nature, poorly managed, and far re- subishi Heavy Industries LTD., part of Japan’s $200 billion
moved from core businesses. Now, the alliances are deepen- keiretsu of the same name. Early on, Cat wanted a way to sell
ing, taking on increasingly important products, and expanding its construction equipment in Japan and compete with rival
their geographic reach in terms of sales. U.S.-Japanese part- Komatsu Ltd. on its home turf. Mitsubishi wanted to play
nerships are, for example, popping up in Asia’s emerging but catch-up with Komatsu, too, and expand its export markets.
tricky markets, reducing the risks each company faces. Their alliance played a key role in taming Komatsu. But the
This deepening web of relationships reflects a quiet change partners have broader ambitions. Since Cat shifted all design
in thinking by Japanese and U.S. multinationals in an era when work for its “300” series of excavators to the partnership back
keeping pace with technological change and competing glob- in 1987, the venture’s two Japanese factories have emerged as
ally have stretched the resources of even the richest compa- Cat’s primary source of production for sales to fast-growing
nies. “The scale and technology are so great that neither can Asia. The alliance’s products reach the world market through
do it alone,” says Jordan D. Lewis, author of The Connected Cat’s network of 186 independent dealers in 197 countries.
Corporation. Source: Brian Bemner in Tokyo, with Zachary Schiller in Cleveland,
Overall, instances of joint investments in research, prod- Tim Smart in Fairfield, William J. Holstein in New York, and bureau
ucts, and distribution by Japanese companies and foreign reports, “Keiretsu Connections,” BusinessWeek, July 22, 1996.
SEQUENCE OF OBJECTIVES AND STRATEGY SELECTION

The selection of long-range objectives and grand strategies involves simultaneous, rather
than sequential, decisions. While it is true that objectives are needed to prevent the firm’s di-
rection and progress from being determined by random forces, it is equally true that objec-
tives can be achieved only if strategies are implemented. In fact, long-term objectives and
grand strategies are so interdependent that some business consultants do not distinguish be-
tween them. Long-term objectives and grand strategies are still combined under the head-
ing of company strategy in most of the popular business literature and in the thinking of most
practicing executives.
222
EXHIBIT 6–16
A Profile of Strategic Choice Options
Six Strategic Choice Options

1 2 3 4 5 6
Interactive Current industry
opportunities West Coast Current markets product lines offer
markets present sensitive to price too narrow a range
little competition competition of markets
Appropriate
long-range
objectives
(limited sample):
Average 5-year ROI. 15% 19% 13% 17% 23% 15%
Company sales by
year 5. ⫹ 50% ⫹ 40% ⫹ 20% ⫹ 0% ⫹ 35% ⫹ 25%
Risk of negative
profits. .30 .25 .10 .15 .20 .05
Grand strategies Horizontal Market Selective Product

integration development Concentration retrenchment development Concentration
However, the distinction has merit. Objectives indicate what strategic managers want but
provide few insights about how they will be achieved. Conversely, strategies indicate what
types of actions will be taken but do not define what ends will be pursued or what criteria
will serve as constraints in refining the strategic plan.
Does it matter whether strategic decisions are made to achieve objectives or to satisfy
constraints? No, because constraints are themselves objectives. The constraint of in-
creased inventory capacity is a desire (an objective), not a certainty. Likewise, the con-
straint of an increase in the sales force does not ensure that the increase will be achieved,
given such factors as other company priorities, labor market conditions, and the firm’s
profit performance.
Summary Before we learn how strategic decisions are made, it is important to understand the two principal com-
ponents of any strategic choice; namely, long-term objectives and the grand strategy. The purpose of
this chapter was to convey that understanding.
Long-term objectives were defined as the results a firm seeks to achieve over a specified period,
typically five years. Seven common long-term objectives were discussed: profitability, productivity,
competitive position, employee development, employee relations, technological leadership, and pub-
lic responsibility. These, or any other long-term objectives, should be acceptable, flexible, measura-
ble over time, motivating, suitable, understandable, and achievable.
Grand strategies were defined as comprehensive approaches guiding the major actions designed
to achieve long-term objectives. Fifteen grand strategy options were discussed: concentrated growth,
market development, product development, innovation, horizontal integration, vertical integration,
concentric diversification, conglomerate diversification, turnaround, divestiture, liquidation, bank-
ruptcy, joint ventures, strategic alliances, and consortia.
Questions 1. Identify firms in the business community nearest to your college or university that you believe
are using each of the 15 grand strategies discussed in this chapter.
for Discussion
2. Identify firms in your business community that appear to rely principally on 1 of the 15 grand
strategies. What kind of information did you use to classify the firms?
3. Write a long-term objective for your school of business that exhibits the seven qualities of long-
term objectives described in this chapter.
4. Distinguish between the following pairs of grand strategies:
a. Horizontal and vertical integration.
b. Conglomerate and concentric diversification.
c. Product development and innovation.
d. Joint venture and strategic alliance.
5. Rank each of the 15 grand strategy options discussed in this chapter on the following three scales:
High Low
Cost
High Low
Risk of failure
High Low
Potential for exceptional growth
6. Identify firms that use one of the eight specific options shown in Exhibit 6–4 under the grand
strategies of concentration, market development, and product development.
Chapter 6 Discussion Case

Novartis
1 Novartis (NVS) Chairman and CEO Daniel L. Vasella cal margins at the Swiss drugmaker powered ahead, to
doesn’t take no for an answer. The head of the world’s 30.5 percent from 28.1 percent year on year. The
sixth-largest drugmaker (by sales) goes after what he stock has climbed 15 percent since mid-March and
wants and, more often than not, gets it. When the continues to outperform the industry (charts).
Swiss company began work on a $4 billion research 4 Now for stage three, elevating Novartis to the pan-
facility in Cambridge, Mass., last year, Vasella de- theon of the truly great global pharmaceutical giants.
cided to draft a world-famous scientist to run it. But Novartis’ No. 6 ranking is good, but more block-
his candidate, Dr. Mark C. Fishman, a renowned ge- busters such as Glivec would make it better. That’s
neticist and cardiologist at Harvard Medical School, where hugely ambitious projects like the Cambridge
flatly refused, saying he was happy in his current job. research center come in. “Personally, I’d simply like
“It has been years since that happened to me,” Vasella to beat the competition,” says Vasella.
recalls with a laugh. But Vasella wore him down. Af- 5 That means building a portfolio of superior drugs.
ter six months of persistent wooing on two continents, Making them in your own labs is one way to do that;
the Cambridge center was up and running by the end buying them from rivals is another. Novartis certainly
of March with Fishman in charge. has money to spend. The Swiss company is sitting on
2 Hiring Fishman—and turning the Cambridge cen- $7 billion in net cash, more than any other drugmaker
ter into a leader in the discovery of cardiovascular, in Europe—more even than the money-spinning
cancer, antiviral, and diabetes drugs—are the latest el- GlaxoSmithKline (GSK) PLC. And that figure is set
ements of a grand plan that the courteous, soft-spoken to rise to $10 billion by yearend, estimates Marc
Swiss has developed with a mixture of patience and Booty, European pharmaceuticals analyst at Com-
quiet ferocity. The first stage was to generate some re- merzbank Securities in London.
spect for Novartis, a product of the 1996 merger of two 6 Vasella has been carefully laying the groundwork
Swiss companies, Sandoz Ltd. and Ciba-Geigy. That for acquisitions. That’s one reason he switched the
was the hard part. Until two years ago, the industry company’s financial reporting to dollars. It makes a
dismissed Novartis as a sleepy European giant without deal with a U.S. company much easier for American
the marketing and sales firepower to compete in the investors to figure out (and signals to Pfizer and
United States, the world’s most lucrative market for Merck that Novartis thinks it’s in the same league).
prescription drugs. There, Novartis was a midtier Takeover candidates? Schering-Plough (SGP) Corp.,
player—certainly no match for Merck (MRK) & Co. for one. Vasella and Schering’s newly appointed CEO,
or Pfizer (PFE) Inc. But Vasella, a physician himself, Fred Hassan, go way back, plus Schering has the ex-
devoted every penny he could find to marketing and clusive rights to sell Novartis’ Foradil for asthma in
research and took the world by surprise in May 2001 the United States. Another possibility is Wyeth,
with Glivec, one of the most effective new cancer ther- whose pipeline would complement Novartis’ own.
apies going. “Novartis is emerging as one of the pre- 7 Big transatlantic deals are notoriously tough due to
mier powerhouses in the global pharmaceuticals regulatory hurdles, so Vasella is not waiting around. In
industry,” says Richard R. Stover, senior analyst with March, Novartis paid $225 million in cash for a major-
brokerage Natexis Bleichroeder Inc. in New York. ity stake in Cambridge (Mass.)–based Idenix Pharma-
3 Glivec’s success set the stage for the next phase of ceuticals Inc. The acquisition gives Novartis access to
the plan: creating a profit machine. On April 15, No- a promising line of new drugs to treat hepatitis B and C.
vartis reported a 24 percent jump in first-quarter op- 8 Certainly, a play for a top American drugmaker
erating earnings, to $1.4 billion, on sales of $5.7 would vastly strengthen Novartis’ hand in the United
billion. That news was better than expected, thanks States, where all of the European pharmaceuticals get
partially to Novartis’ decision to begin reporting re- the bulk of their profits, thanks to higher prices for pre-
sults in dollars rather than in Swiss francs. A currency scription drugs and doctors’ willingness to prescribe
switch isn’t the whole story, though. Despite higher innovative treatments, regardless of the cost. But
spending on research and development, pharmaceuti- Vasella is already working on a deal closer to home
that could, in a stroke, turn Novartis into the second- Glivec also is used to treat other rare types of cancer
biggest pharmaceutical company on the planet, behind such as gastrointestinal stromal tumors (GIST) and is
Pfizer. This is a target Vasella can practically see from now being tested in combination with other drugs in
his office window: Roche Group, also based in Basel. fighting prostate cancer. “Novartis shows other drug-
9 A union between the crosstown rivals would have makers that these little niches can be extraordinarily
repercussions far beyond this picturesque city on the valuable scientifically, as well as commercially feasi-
Rhine. The merged company would have sales of more ble,” says Dr. George D. Demetri, director of the sar-
than $45 billion, a nearly 7 percent share of the global coma center at Harvard Medical School’s
market, a powerful cancer franchise, and one of the best Dana-Farber Cancer Institute in Boston. Other drug-
biotech research facilities around, thanks to Roche’s makers already are developing targeted drugs, such
ownership of U.S. biotech Genentech (DNA) Inc. No- as AstraZenecas (AZN) Iressa for lung cancer, and
vartis already owns 32.7 percent of Roche, just under ImClone (IMCLE) Erbitux, for colorectal cancer.
the one-third stake that would require the company to 14 Glivec, introduced in the United States in 2001 un-
make a formal bid under Swiss stock exchange rules. der the brand name Gleevec, was worth every penny
10 There’s just one hitch: Roche CEO Franz B. Humer that Novartis invested. Sales rose more than 300 per-
is staunchly opposed to any deal. “We are better off as cent in 2002, and could hit the $1 billion mark by the
an independent company, and a megamerger with No- end of this year, according to Commerzbank’s Booty.
vartis or anyone else is not an answer,” he says. And for Although an annual course of Glivec can cost as
now, at least, Humer has the backing of the descendants much as $25,000, demand for the drug took off so
of founder Fritz Hoffman-La Roche, who control the quickly that Novartis was forced to run its production
majority of the company’s voting rights despite owning line around the clock. One of the first patients to have
less than 10 percent of the equity. André Hoffman, the access to the medicine was Anita Scherzer of Little
family spokesman, vows Roche will elude takeover. Falls, N.J. In 1994, the then 52-year-old Scherzer was
11 Vasella is equally determined to make it happen. diagnosed with gastrointestinal stromal tumors. She
“There has been value destruction [at Roche], and as underwent countless surgeries to remove tumors in
a shareholder, one can’t be happy with that,” he says. her stomach and liver, followed by chemotherapy, but
“Roche’s management and board need to do the right the cancer kept spreading. She enrolled in a small
thing for all [of] their shareholders.” Roche shares clinical trial for Glivec in August 2000. Just 10 days
have declined 16 percent in the last 12 months. The after taking her first dose of the drug, doctors were
company posted a $3 billion loss in 2002 due mainly astonished to discover that a tumor in Anita’s liver had
to the poor performance of its investment portfolio. shrunk. Just a month after starting treatment, she was
12 Vasella can afford to bide his time. Novartis’ in remission. “I knew I was getting better when I went
pipeline is full, a rarity in the industry. The company for a biopsy and the doctor couldn’t find the tumor,”
has launched 10 drugs since 2000, three times more Scherzer says. Glivec is not a magic bullet, though.
than its nearest rival. Another 15 are expected to de- Some patients have developed resistance to the drug.
but by 2006. Among the current crop are Zelmac, a 15 Glivec’s success stems from Novartis’ stress on
drug for irritable-bowel syndrome; eczema treatment science. Under the leadership of Joerg Reinhardt, a
Elidel; and Zometa, a treatment for bone metastases. 20-year company veteran who heads global develop-
What’s more, none of Novartis’ major moneymakers ment, the company has shaved nearly two years off
is set to go off-patent soon. Earnings should rise al- the time it takes to bring a drug from clinic to market.
most 10 percent this year; they would go higher were Novartis now needs just over 7 years—18 months
it not for Vasella’s insistence on ramping up the re- less than the industry average.
search budget to $3.5 billion in 2003, equal to 17.5 16 He did it partly by running discovery-and-
percent of sales, well above the industry average. development projects in parallel instead of sequentially.
13 Then there’s Glivec, the first treatment ever That means a potential drug being tested for colon can-
proven to cause certain types of tumors to disappear. cer might simultaneously be screened for effectiveness
While other cancer drugs work indiscriminately, against lung cancer or even schizophrenia. Before the
killing off healthy cells along with sick ones, Glivec mapping of the human genome, scientists made such
is part of a new class of drugs that interfere with the discoveries by chance. Today, technologies such as
proteins that cause tumors to grow. Initially approved functional genomics, in which Novartis invests approx-
for the treatment of chronic myeloid leukemia, imately $150 million a year, have given scientists a bet-
ter understanding of the molecular causes of some dis- marketing support, Elidel became the No. 1 branded
eases. Vasella wants the Cambridge center to be at the eczema product in the United States after just four
forefront of this type of research. months on the market. “They’ve changed the mar-
17 Reinhardt’s breakthrough is due in part to the con- ket’s perception about how well a European company
stant pressure Vasella puts on employees to beat in- can compete in the United States,” says Com-
dustry benchmarks. Employees describe him as a merzbank’s Booty. Today, U.S. sales account for 43
demanding boss with exceptionally high standards. percent of overall revenues. Credit also goes to
When Vasella saw the early clinical results on Glivec, Thomas Ebeling, a marketing whiz from PepsiCo
he gave the development team just two years to bring (PEP) Inc., who was promoted in July, 2001, to head
the drug to market. “When I think something needs Novartis global pharmaceutical business. In a quest
to be done,” says Vasella, “I generally think it needs to create global brands, Ebeling decided to devote
to be done quickly.” more than 50 percent of the Novartis’ marketing
18 Novartis’ boss is an unusual mix, an aggressive budget to a handful of drugs, such as hypertension
manager who still keeps something of the gentle bed- medicine Diovan, Lotrel, Glivec, and Zometa.
side manner he developed as a general practitioner. 22 Vasella increasingly sees the United States as vital
Although Vasella recognizes his first loyalty is to his to the company’s destiny (a merger with Roche, which
shareholders, he never loses sight of the patients. It’s relies so much on California-based Genentech for its
an attitude that grows out of his own admiration for pipeline and profits, would reinforce Novartis’Ameri-
the doctors who treated him as a child, when he con- can position).That’s why he has been shifting more and
tracted tuberculosis and meningitis. Vasella is also an more of the company’s R&D to the United States, a
unbuttoned type who likes roaring around the Swiss country which he says has a much better regulatory and
countryside on his BMW bike. scientific environment for drugmakers than Europe.
19 Vasella’s rivals underestimated him at first, espe- This year alone, spending on R&D is set to rise by 20
cially when he embarked on the merger of Sandoz percent, to $3.5 billion, to cover the development of
and Ciba. The companies were old-style conglomer- new drugs such as Prexige, a treatment for osteoarthri-
ates with roots in the agrichemicals industry, but with tis and acute pain, and Xolair, for severe asthma.
very different corporate cultures. Sandoz was auto- 23 Still, there are considerable risks. Vasella con-
cratic and hierarchical, while at Ciba a collegial and cedes that the big boost in R&D spending will put
informal atmosphere bred better morale but little ac- pressure on margins and earnings. But he contends
countability among the staff. “It was a difficult mar- that this is inevitable if Novartis wants to keep inno-
riage to make work,” says Natexis’ Stover. Vasella’s vating. “It’s not an option to stand still,” he says. His
appointment to the top job at the newly merged com- biggest challenge will be revving up sales of new
pany in March, 1996, fueled accusations of nepotism drugs to offset the large increases in investment. It
(his high-school sweetheart and wife of 25 years, won’t be easy. Many of Novartis’ newer drugs are in
Anne-Laurence, is the niece of Sandoz’ former chair- either crowded or immature markets. Prexige, slated
man) and grumblings that he was in over his head. for launch in mid-2004, will be the fifth entrant into
20 Determined to prove critics wrong, the new boss a large field dominated by Pharmacia’s Celebrex. To
promptly set about cleaning house. After much- make a dent, analysts estimate Novartis may have to
touted synergies failed to materialize, he dumped the spend as much as $1 billion in the first three years af-
company’s ailing agrochemicals unit to focus on ter launch.
higher-margin pharmaceuticals. He also rapidly 24 Costly stuff. But Vasella has deep pockets. In
boosted R&D spending. March, Novartis acquired the rights to Pfizer’s incon-
21 But one of Vasella’s shrewdest moves was to tinence drug Enablex for $255 million, beating out
sharpen marketing in the United States, one of No- bigger players such as GlaxoSmithKline. The drug,
vartis’ big weaknesses. So in 1999 he hired Paulo which Pfizer was forced to sell as part of an antitrust
Costa, a former Johnson & Johnson (JNJ) exec, to agreement before it could take over Pharmacia, is
head Novartis’ stateside pharmaceutical business. considered a potential billion-dollar blockbuster. One
Costa doubled the size of the U.S. sales force to 6,200 way or another, the doctor is determined to build his
and this year tripled spending on direct-to-consumer powerhouse.
advertising to $120 million. So far, it seems to be Source: Kerry Capell, “Novartis,” BusinessWeek, May 26,
working: Launched in March 2002 with massive 2003

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Pearce−Robinson: II. Strategy Formulation 6.

Formulating Long−Term © The McGraw−Hill

Strategic analysis and choice

Long-term objectives Generic and grand strategies

Restructuring, reengineering, and

Strategic control and continuous improvement

Chapter 6 Formulating Long-Term Objectives and Grand Strategies 191

192 Part Two Strategy Formulation

Public Responsibility Managers recognize their responsibilities to their customers and to

Chapter 6 Formulating Long-Term Objectives and Grand Strategies 193

Qualities of Long-Term Objectives

Flexible Objectives should be adaptable to unforeseen or extraordinary changes in the

Understandable Strategic managers at all levels must understand what is to be achieved.

194 Part Two Strategy Formulation

The Balanced Scorecard

Source: Adapted and reprinted

by permission of Harvard "To succeed

Business Review. Exhibit from financially, how

“Using the Balanced Scorecard should we

"To achieve our “To satisfy our

vision, how shareholders and

should we and customers, at

Learning and Growth

"To achieve our

vision, how will

Chapter 6 Formulating Long-Term Objectives and Grand Strategies 195

196 Part Two Strategy Formulation

EXHIBIT 6–2 Generic Commonly Required Skills Common Organizational

Chapter 6 Formulating Long-Term Objectives and Grand Strategies 197

EXHIBIT 6–3 Risks of Cost Leadership Risks of Differentiation Risks of Focus

THE VALUE DISCIPLINES

198 Part Two Strategy Formulation

Chapter 6 Formulating Long-Term Objectives and Grand Strategies 199

telephone-computer system capable of recognizing individual clients by their telephone

200 Part Two Strategy Formulation

Chapter 6 Formulating Long-Term Objectives and Grand Strategies 201

Rationale for Superior Performance

Conditions That Favor Concentrated Growth

202 Part Two Strategy Formulation

Risk and Rewards of Concentrated Growth

Chapter 6 Formulating Long-Term Objectives and Grand Strategies 203

Concentrated Growth Is Often the Most Viable Option

204 Part Two Strategy Formulation

EXHIBIT 6–4 Concentration (increasing use of present products in present markets):

Chapter 6 Formulating Long-Term Objectives and Grand Strategies 207

Global Strategy in Action

than 2 percent of the innovative projects initially considered by 51 companies eventually

Chapter 6 Formulating Long-Term Objectives and Grand Strategies 209

Shirt manufacturer Shirt manufacturer

Clothing store Clothing store

Acquisitions or mergers of suppliers or customer businesses

Acquisitions or mergers of competing businesses

210 Part Two Strategy Formulation

1. The wrong target. 5. Management difficulties.

212 Part Two Strategy Formulation

Chapter 6 Formulating Long-Term Objectives and Grand Strategies 213

EXHIBIT 6–11 A Model of the Turnaround Process

Internal Declining Cost Efficiency

External Imminent Asset Entrepreneurial

214 Part Two Strategy Formulation

underwear, and household products. He divested 15 businesses, including Coach leather

216 Part Two Strategy Formulation

The Bankruptcy Situation

The Harshest Resolution